Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended August 31, 2014

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 001-35214

 

 

API TECHNOLOGIES CORP.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware		98-0200798
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

4705 S. Apopka Vineland Rd. Suite 210

Orlando, FL 32819

(Address of Principal Executive Offices)

(855) 294-3800

(Registrant’s Telephone Number, Including Area Code)

 

 

Indicate by check mark whether the registrant: (1) filed all reports required to be filed by Section 13 and 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company (as defined Rule 12b-2 of the Exchange Act).

 

Large Accelerated Filer		¨		Accelerated Filer		x
Non-Accelerated Filer		¨		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

State the number of shares outstanding of each of the issuer’s class of common equity as of the latest practicable date:

55,397,384 shares of common stock with a par value of $0.001 per share at October 1, 2014.

 

 

 

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API TECHNOLOGIES CORP. AND SUBSIDIARIES

Report on Form 10-Q

Quarter Ended August 31, 2014

Table of Contents

 

				Page
PART I—FINANCIAL INFORMATION
Item 1.		Financial Statements (unaudited)			3
		Consolidated Balance Sheets at August 31, 2014 and November 30, 2013			3
		Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and nine months ended August 31, 2014 and 2013			4
		Consolidated Statement of Changes in Redeemable Preferred Stock and Shareholders’ Equity for the nine months ended August 31, 2014			5
		Consolidated Statements of Cash Flows for the nine months ended August 31, 2014 and 2013			6
		Notes to Consolidated Financial Statements			7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			25
		Forward-Looking Statements			36
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			37
Item 4.		Controls and Procedures			37
PART II—OTHER INFORMATION
Item 1.		Legal Proceedings			38
Item 1A.		Risk Factors			38
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			38
Item 3.		Defaults Upon Senior Securities			38
Item 4.		Mine Safety Disclosures			38
Item 5.		Other Information			38
Item 6.		Exhibits			39
Signatures					40

 

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PART I—FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

API TECHNOLOGIES CORP.

Consolidated Balance Sheets

(unaudited) (Dollar Amounts in Thousands)

 

		August 31, 2014				November 30, 2013
Assets
Current
Cash and cash equivalents		$	7,721			$	6,351
Restricted cash (note 4b)			—				1,500
Accounts receivable, less allowance for doubtful accounts of $892 and $697 at August 31, 2014 and November 30, 2013, respectively			41,422				39,751
Inventories, less provision for obsolescence of $11,559 and $12,571 at August 31, 2014 and November 30, 2013, respectively (note 6)			54,609				58,218
Deferred income taxes			2,302				2,426
Prepaid expenses and other current assets			1,226				2,445
			107,280				110,691
Fixed assets, net			30,787				35,231
Fixed assets held for sale (note 2)			150				150
Goodwill			116,770				116,770
Intangible assets, net			32,002				38,780
Other non-current assets			1,665				2,956
Total assets		$	288,654			$	304,578
Liabilities, Redeemable Preferred Stock and Shareholders’ Equity
Current
Accounts payable and accrued expenses		$	27,539			$	32,217
Deferred revenue			3,340				3,519
Current portion of long-term debt (note 9)			9,286				8,155
			40,165				43,891
Deferred income taxes			5,544				5,517
Other long-term liabilities			1,106				1,135
Long-term debt, net of current portion, and discount of $0 and $8,100 at August 31, 2014 and November 30, 2013, respectively (note 9)			120,778				96,606
Deferred gain (note 9d)			7,937				—
			175,530				147,149
Commitments and contingencies (note 15)
Redeemable Preferred Stock
Preferred stock (Series A Mandatorily Redeemable Preferred Stock, $0 and $1,042 liquidation preference and 1,000,000 authorized shares, 0 and 26,000 shares issued and outstanding at August 31, 2014 and November 30, 2013, respectively) (note 10)			—				26,326
Shareholders’ Equity
Common shares ($0.001 par value, 250,000,000 authorized shares, 55,397,320 and 54,846,071 shares issued and outstanding at August 31, 2014 and November 30, 2013, respectively)			55				55
Special voting stock ($0.01 par value, 1 share authorized, issued and outstanding at August 31, 2014 and November 30, 2013, respectively)			—				—
Additional paid-in capital			327,763				327,901
Common stock subscribed but not issued			2,373				2,373
Accumulated deficit			(218,933	)			(200,798	)
Accumulated other comprehensive income			1,866				1,572
			113,124				131,103
Total Liabilities, Redeemable Preferred Stock and Shareholders’ Equity		$	288,654			$	304,578

The accompanying notes are an integral part of these consolidated financial statements.

 

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API TECHNOLOGIES CORP.

Consolidated Statements of Operations and Comprehensive Income (Loss)

(unaudited) (Dollar Amounts in Thousands, Except Per Share Data)

 

		For the Three Months Ended August 31, 2014				For the Three Months Ended August 31, 2013				For the Nine Months Ended August 31, 2014				For the Nine Months Ended August 31, 2013
Revenue, net		$	56,924			$	62,630			$	169,011			$	185,163
Cost of revenues
Cost of revenues			41,751				47,641				129,502				143,338
Restructuring charges			364				16				945				182
Total cost of revenues			42,115				47,657				130,447				143,520
Gross profit			14,809				14,973				38,564				41,643
Operating expenses
General and administrative			6,030				6,901				17,568				19,704
Selling expenses			3,743				3,505				11,037				11,263
Research and development			1,980				2,244				6,214				6,885
Business acquisition and related charges			190				(111	)			375				977
Restructuring charges			133				120				1,000				684
Total operating expenses			12,076				12,659				36,194				39,513
Operating income			2,733				2,314				2,370				2,130
Other expenses, net
Interest expense, net			3,289				3,086				8,586				11,907
Amortization of note discounts and deferred financing costs			24				521				10,916				11,795
Other expenses (income), net			24				189				(88	)			(186	)
Total other expenses, net			3,337				3,796				19,414				23,516
Loss from continuing operations before income taxes & discontinued operations			(604	)			(1,482	)			(17,044	)			(21,386	)
Expense (benefit) for income taxes			30				(3,144	)			698				(3,316	)
Income (loss) from continuing operations			(634	)			1,662				(17,742	)			(18,070	)
Income from discontinued operations, net of income taxes			—				5,305				—				18,085
Net income (loss)		$	(634	)		$	6,967			$	(17,742	)		$	15
Accretion on preferred stock			—				(381	)			(393	)			(671	)
Net income (loss) attributable to common shareholders		$	(634	)		$	6,586			$	(18,135	)		$	(656	)
Income (loss) per share from continuing operations—Basic and diluted		$	(0.01	)		$	0.02			$	(0.33	)		$	(0.34	)
Income per share from discontinued operations—Basic and diluted		$	0.00				0.10			$	0.00				0.33
Net income (loss) per share—Basic and diluted		$	(0.01	)		$	0.12			$	(0.33	)		$	(0.01	)
Weighted average shares outstanding
Basic			55,461,217				55,424,157				55,444,759				55,398,833
Diluted			55,461,217				55,424,157				55,444,759				55,398,833
Comprehensive income (loss)
Unrealized foreign currency translation adjustment			(128	)		$	53				294			$	(1,237	)
Other comprehensive income (loss)			(128	)			53				294				(1,237	)
Comprehensive income (loss)			(762	)		$	7,020				(17,448	)		$	(1,222	)

The accompanying notes are an integral part of these consolidated financial statements.

 

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API TECHNOLOGIES CORP.

Consolidated Statement of Changes in Redeemable Preferred Stock and Shareholders’ Equity

(Unaudited)

(In thousands of dollars, except share data)

 

		Preferred Stock- number of shares				Preferred stock amount				Common stock- number of shares				Common stock amount				Additional paid- in capital				Common stock subscribed but not issued				Accumulated deficit				Accumulated other comprehensive income				Total shareholders’ equity
Balance at November 30, 2013			26,000			$	26,326				54,846,071			$	55			$	327,901			$	2,373			$	(200,798	)		$	1,572			$	131,103
Stock issued as compensation			—				—				48,333				—				—				—				—				—				—
Stock withheld for taxes			—				—				(13,751	)			—				(39	)			—				—				—				(39	)
Accretion on Redeemable Preferred Stock (Dividends see Note 10)			—				393				—				—				—				—				(393	)			—				(393	)
Accrued dividend in kind (effective) on Series A Mandatorily Redeemable Preferred Stock (see Note 10)			—				42				—				—				—				—				—				—				—
Redemption of Preferred Stock (see Note 10)			(26,000	)			(26,761	)			—				—				—				—				—				—				—
Stock-based compensation expense			—				—				—				—				(99	)			—				—				—				(99	)
Stock exchanged for subsidiary exchangeable shares and stock subject to issuance in connection with plan of arrangement (Note 11)			—				—				516,667				—				—				—				—				—				—
Net loss for the period			—				—				—				—				—				—				(17,742	)			—				(17,742	)
Other comprehensive income			—				—				—				—				—				—				—				294				294
Balance at August 31, 2014			—			$	—				55,397,320			$	55			$	327,763			$	2,373			$	(218,933	)		$	1,866			$	113,124

The accompanying notes are an integral part of these consolidated financial statements.

 

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API TECHNOLOGIES CORP.

Consolidated Statements of Cash Flows

(Unaudited) (Dollar Amounts in Thousands)

 

		Nine Months Ended August 31,
		2014				2013
Cash flows from operating activities
Net income (loss)		$	(17,742	)		$	15
Less: Income from discontinued operations			—				(18,085	)
Adjustments to reconcile net income (loss) to net cash used by operating activities:
Depreciation and amortization			12,269				13,225
Amortization of note discounts and deferred financing costs			705				1,519
Amortization of note discounts and deferred financing costs due to debt extinguishment			10,212				10,277
Stock based compensation			(99	)			791
Gain on sale of fixed assets			(156	)			—
Accrued income tax			—				(7,373	)
Deferred income taxes			151				751
Changes in operating asset and liabilities, net of business acquisitions
Accounts receivable			(2,839	)			(2,296	)
Inventories			3,544				(3,893	)
Prepaid expenses and other current assets			1,220				378
Accounts payable and accrued expenses			(4,491	)			(1,914	)
Deferred revenue			(795	)			(166	)
Net cash provided (used) by continuing activities			1,979				(6,771	)
Net cash provided by discontinued operations			—				2,639
Net cash provided (used) by operating activities			1,979				(4,132	)
Cash flows from investing activities
Purchase of fixed assets			(1,598	)			(2,084	)
Purchase of intangible assets			(191	)			(463	)
Net proceeds from disposal of discontinued operations (note 4)			—				80,498
Net proceeds from disposal of fixed assets (note 9d)			15,108				739
Restricted cash			1,500				(800	)
Business acquisitions (note 13)			1,288				(600	)
Discontinued operations			—				(17	)
Net cash provided by investing activities			16,107				77,273
Cash flows from financing activities
Redemption of preferred shares (note 10)			(27,600	)			—
Repayments of long-term debt (note 9)			(54,017	)			(296,362	)
Net proceeds from long-term debt (note 9)			64,770				215,678
Net cash used by financing activities			(16,847	)			(80,684	)
Effect of exchange rate on cash and cash equivalents			131				(478	)
Net change in cash and cash equivalents			1,370				(8,021	)
Cash and cash equivalents, beginning of period—continuing operations			6,351				20,550
Cash and cash equivalents, beginning of period—discontinued operations			—				(15	)
Cash and cash equivalents, beginning of period			6,351				20,535
Cash and cash equivalents, end of period		$	7,721			$	12,514
Cash and cash equivalents, end of period—discontinued operations			—				—
Cash and cash equivalents, end of period—continuing operations		$	7,721			$	12,514

The accompanying notes are an integral part of these consolidated financial statements.

 

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API Technologies Corp.

Notes to Consolidated Financial Statements

(Unaudited) (Dollar Amounts in Thousands, Except Per Share Data)

1. NATURE OF BUSINESS AND BASIS OF PRESENTATION

Nature of Business

API Technologies Corp. (“API”, and together with its subsidiaries, the “Company”) designs, develops, and manufactures systems, subsystems, modules, and components for RF/microwave, millimeter wave, electromagnetic, power, and security applications, as well as provides electronics manufacturing for technically demanding, high-reliability applications.

On December 31, 2013, the Company completed the sale and leaseback (the “Sale/Leaseback”) of the Company’s facility located in State College, Pennsylvania. The Company sold the facility to an unaffiliated third party for a purchase price of approximately $15,500 and will lease the property from the buyer for approximately $1,279 per year, subject to annual adjustments. The Company used $14,200 of the proceeds of the Sale/Leaseback to prepay a portion of its outstanding term loan indebtedness.

On July 5, 2013, the Company entered into an agreement (the “APA”) with ILC Industries, LLC (“Parent”) and Data Device Corporation, a Delaware corporation and a wholly owned subsidiary of Parent (the “Purchaser”) pursuant to which the Company sold to the Purchaser certain assets comprising the Company’s data bus business (“Data Bus”) in the U.S. and the U.K., including substantially all of the assets of the Company’s wholly owned subsidiary, National Hybrid, Inc., a New York corporation (the “Asset Sale”). The Purchaser paid the Company approximately $32,150 in cash for the assets, after certain adjustments based on closing inventory values as set forth in the APA and customary indemnification provisions. Substantially all of the proceeds from the Asset Sale were used to repay certain of the Company’s outstanding debt.

On April 17, 2013, the Company sold all of the issued and outstanding shares of capital stock or other equity interests of Spectrum Sensors and Controls, Inc., a Pennsylvania corporation (“Sub 1”), Spectrum Sensors and Controls, LLC, a California limited liability company (“Sub 2”), and Spectrum Sensors and Controls, Inc., an Ohio corporation (“Sub 3” and together with Sub 1 and Sub 2, “Sensors”), for gross cash proceeds of approximately $51,350. Of this amount, $1,500 was initially placed into an escrow account for 12 months to secure any indemnification claims made by the purchaser against the sellers, API and Spectrum Control, Inc. (“Spectrum”), a wholly owned subsidiary of API and was paid in April 2014.

The unaudited consolidated financial statements include the accounts of API and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. There are no other entities controlled by the Company, either directly or indirectly. The financial statements have been prepared in accordance with the requirements of Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (the “SEC”).

Accordingly, certain information and footnote disclosures required in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) that the Company considers necessary for the fair presentation of the Company’s consolidated financial position as of August 31, 2014 and the results of its operations and cash flows for the three and nine month periods ended August 31, 2014. Results for the interim period are not necessarily indicative of results that may be expected for the entire year or for any other interim periods. The unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements of the Company and the notes thereto as of and for the year ended November 30, 2013 included in the Company’s Form 10-K filed with the SEC on February 12, 2014.

 

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2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Accounting Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make certain estimates and assumptions that affect the reported amounts in the consolidated financial statements, and the disclosures made in the accompanying notes. Examples of estimates include the provisions made for bad debts and obsolete inventory, estimates associated with annual goodwill impairment tests, and estimates of deferred income tax and liabilities. The Company also uses estimates when assessing fair values of assets and liabilities acquired in business acquisitions as well as any fair value and any related impairment charges related to the carrying value of machinery and equipment, other long-lived assets, fixed assets held for sale and discontinued operations. The Company also uses estimates in determining the remaining economic lives of long-lived assets. In addition, the Company uses assumptions when employing the Black-Scholes valuation model to estimate the fair value of share options. Despite the Company’s intention to establish accurate estimates and use reasonable assumptions, actual results may differ from these estimates.

Inventories

Inventories, which include materials, labor, and manufacturing overhead, are stated at the lower of cost (on a first-in, first-out basis) or net realizable value. On a quarterly basis, the Company evaluates inventories for potential write-down for identifiable obsolescence and slow moving items. The evaluation includes analysis of future demand, product mix and possible alternative uses. The Company records a provision for both excess and obsolete inventory when write-downs or write-offs are identified. Any write-down of inventory at the close of a fiscal period creates a new cost basis that subsequently would not be marked up based on changes in underlying facts and circumstances.

Fixed Assets

Fixed assets are recorded at cost less accumulated depreciation and are depreciated using the straight-line method over the following periods:

 

Straight line basis
Buildings and leasehold improvements			5-40 years
Computer equipment			3-5 years
Furniture and fixtures			5-8 years
Machinery and equipment			5-10 years
Vehicles			3 years

Betterments are capitalized and amortized by the Company, using the same amortization basis as the underlying assets over the remaining useful life of the original asset. Betterments include renovations, major repairs and upgrades that increase the service of a fixed asset and extend the useful life. Gains and losses on depreciable assets retired or sold are recognized in the consolidated statements of operations in the year of disposal. Repairs and maintenance expenditures are expensed as incurred.

Fixed Assets Held for Sale

Certain fixed assets held for sale from within our SSC segment have been classified as held for sale in the consolidated balance sheets. The Company estimated the fair value of the net assets to be sold at approximately $150 at August 31, 2014. This land and building were part of the fixed assets held for sale reported at November 30, 2013.

Discontinued Operations

Components of the Company that have been disposed of are reported as discontinued operations. The results of operations of Data Bus and Sensors for prior periods are reported as discontinued operations (Note 4) and not included in the continuing operations.

 

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Goodwill and Intangible Assets

Goodwill and intangible assets result primarily from business acquisitions accounted for under the purchase method. Goodwill and intangible assets with indefinite lives are not amortized but are subject to impairment by applying a fair value based test. The Company completes an annual (or more often if impairment indicators arise under the applicable accounting guidance) impairment assessment of its goodwill on a reporting unit level. The Company’s annual impairment test for goodwill is September 1^st.

Intangible assets that have a finite life are amortized using the following basis over the following periods:

 

Non-compete agreements		Straight line over 5 years
Computer software		Straight line over 3-5 years
Customer related intangibles		Straight line or the pattern in which the economic benefits are expected to be realized, over an estimated life of 4-15 years
Marketing related intangibles		The pattern in which the economic benefits are expected to be realized, over an estimated life of 3-10 years
Technology related intangibles		The pattern in which the economic benefits are expected to be realized, over an estimated life of 10 years

Long-Lived Assets

The Company periodically evaluates the net realizable values of long-lived assets, principally identifiable intangibles and capital assets, for potential impairment when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, as determined based on the estimated future undiscounted cash flows. If such assets were considered to be impaired, the carrying value of the related assets would be reduced to their estimated fair value.

Income Taxes

Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial reporting and tax bases of assets and liabilities and available net operating loss carry forwards. A valuation allowance is established to reduce tax assets if it is more likely than not that all or some portions of such tax assets will not be realized.

The Company’s valuation allowance was recorded on the deferred tax assets to provide for a reasonable provision, which in the Company’s estimation is more likely than not that all or some portions of such tax assets will not be realized. In determining the adequacy of the valuation allowance, the Company applied the authoritative guidance, and considered such factors as (i) which subsidiaries were producing income and which subsidiaries were producing losses and (ii) temporary differences occurring from depreciation and amortization which the Company expects to increase the taxable income over future periods.

The Company follows the guidance concerning accounting for uncertainty in income taxes, which clarifies the accounting and disclosure for uncertainty in tax positions. The guidance requires that the Company determine whether it is more likely than not that a tax position will not be sustained upon examination by the appropriate taxing authority. If a tax position does not meet the more likely than not recognition criterion, the guidance requires that the tax position be measured at the largest amount of benefit greater than 50 percent not likely of being sustained upon ultimate settlement.

Based on the Company’s evaluation, management has concluded that there are no significant uncertain tax positions requiring recognition in the consolidated financial statements or adjustments to deferred tax assets and related valuation allowance. Tax years 2010-2013 remain open to examination by the Internal Revenue Service or other tax jurisdictions to which the Company is subject.

The Company from time to time has been assessed interest or penalties by major tax jurisdictions, however such assessments historically have been minimal and immaterial to our financial results. If the Company receives an assessment for interest and/or penalties, it would be classified in the consolidated financial statements as general and administrative expense.

Revenue Recognition

The Company recognizes non-contract revenue when it is realized or realizable and earned. The Company considers non-contract revenue realized or realizable and earned when it has persuasive evidence of an arrangement, delivery has occurred, the sales price is fixed or determinable, and collectability is reasonably assured. Delivery is not considered to have occurred until products have been shipped and risk of loss and ownership has transferred to the client. Revenue from production-type contracts, which represents less

 

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than one per cent of total revenue, is recognized using the percentage of completion method. The degree of completion is determined based on costs incurred, excluding costs that are not representative of progress to completion, as a percentage of total costs anticipated for each contract. A provision is made for losses on contracts in progress when such losses first become known. Revisions in cost and profit estimates, which can be significant, are reflected in the accounting period in which the relevant facts become known. Revenue from contracts under the percentage of completion method is not significant to the financial statements.

Deferred Revenue

The Company defers revenue when payment is received in advance of the service or product being shipped or delivered, including transition services agreements related to discontinued operations. For some of the larger government contracts, the Company will bill upon meeting certain milestones. These milestones are established by the customer and are specific to each contract. Unearned revenue is recorded as deferred revenue. The Company generally recognizes revenue on these larger government contracts when items are shipped.

Research and Development

Research and development costs are expensed when incurred.

Stock-Based Compensation

The Company follows the authoritative guidance for accounting for stock-based compensation. The guidance requires that new, modified and unvested stock-based payment transactions with employees, such as grants of stock options, restricted stock units (“RSUs”) and restricted stock, be recognized in the financial statements based on their fair value at the grant date and recognized as compensation expense over their vesting periods. Stock-based compensation cost for RSUs is measured based on the closing fair market value of the Company’s common stock on the date of grant. The fair value of each option granted is estimated on the grant date using the Black-Scholes option pricing model which takes into account as of the grant date the exercise price and expected life of the option, the current price of the underlying shares and its expected volatility, expected dividends on the shares and the risk-free interest rate for the term of the option.

Foreign Currency Translation and Transactions

The Company’s functional currency is United States dollars and the consolidated financial statements are stated in United States dollars, “the reporting currency.” Integrated operations have been translated from various foreign currencies (Canadian dollars, British Pounds Sterling, Chinese Yuan, Euros, and Mexican Pesos) into United States dollars at the period-end exchange rate for monetary balance sheet items, the historical rate for fixed assets and shareholders’ equity, and the average exchange rate for the year for revenues, expenses, gains and losses. The gains or losses on translation are included as a component of other comprehensive income (loss) for the period.

Financial Instruments

The fair values of financial instruments including cash and cash equivalents, accounts receivable, accounts payable, and short-term borrowings approximate their carrying values due to the short-term nature of these instruments. Unless otherwise noted, it is management’s opinion that the Company is not exposed to significant interest rate, currency or credit risks arising from its financial instruments. The recorded value of long-term debt approximates the fair value of the debt as the terms and rates approximate market rates.

In the ordinary course of business, the Company carries out transactions in various foreign currencies (Canadian Dollars, British Pounds Sterling, Chinese Yuan, Euros, and Mexican Pesos) included in the Company’s cash, accounts receivable, accounts payable, bank indebtedness, as well as a mortgage loan. The translation adjustments related to these accounts have been reflected as a component of comprehensive income. Currently, the Company does not maintain a foreign currency hedging program.

Derivative Liabilities

Fair value accounting requires bifurcation of embedded derivative instruments of convertible debt or equity instruments, and measurement of their fair value for accounting purposes. The Company’s embedded derivative instruments such as put and call features, make whole provisions and default interest and dividend rates in the convertible note and convertible preferred stock are measured at fair value using the discounted cash flows model by taking the present value of probability weighted cash flow scenarios. Derivative liabilities are adjusted to reflect fair value at the end of each reporting period, with any change in the fair value being recorded in results of operations as Other expense (income), net.

 

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Debt Issuance Costs and Long-term Debt Discounts

Fees paid to obtain debt financing or amendments under such debt financing are treated as debt issuance costs and are capitalized and amortized over the life of the debt using the effective interest method. These payments are shown as a financing activity on the consolidated statement of cash flows and are shown as other non-current assets in the consolidated balance sheets.

In accordance with accounting standards the Company recognized the value of detachable warrants issued in conjunction with the issuance of the secured promissory notes and the modification of the convertible promissory notes. The Company valued the warrants using the Black-Scholes pricing model. The Company recorded the warrant relative fair value as an increase to additional paid-in capital and a discount against the related debt. The discount attributed to the value of the warrants was being amortized over the term of the underlying debt using the effective interest method and was written off when the related debt was extinguished.

The Company may record debt and equity discounts in connection with raising funds through the issuance of convertible notes or equity instruments. These discounts may arise from (i) the receipt of proceeds less than the face value of the convertible notes or equity instruments, (ii) beneficial conversion features and/or (iii) recording derivative liabilities related to embedded features. These costs are amortized over the life of the debt to interest expense utilizing the effective interest method. If a conversion of the underlying debt occurs, a proportionate share of the unamortized discount is immediately expensed.

Concentration of Credit Risk

The Company maintains cash balances, at times, with financial institutions, which are in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC), Canadian Deposit Insurance Corporation (CDIC) and Financial Services Compensation Scheme (FSCS in the United Kingdom). Management monitors the soundness of these institutions and has not experienced any collection losses with these institutions.

The US, Canadian and United Kingdom Governments’ Departments of Defense (directly and through subcontractors) accounts for approximately 46%, 3% and 11% of the Company’s revenues for the nine months ended August 31, 2014 (48%, 2% and 8% for the nine months ended August 31, 2013), respectively. A loss of a significant customer could adversely impact the future operations of the Company.

Earnings (Loss) per Share of Common Stock

Basic earnings per share of common stock is computed by dividing income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share of common stock gives effect to all dilutive potential shares of common stock outstanding during the period. The computation of diluted earnings per share does not assume conversion, exercise or contingent exercise of securities that would have an anti-dilutive effect on earnings per share (Note 14).

Comprehensive Income (Loss)

Comprehensive income (loss), which includes foreign currency translation adjustments, is shown in the Consolidated Statement of Operations and Comprehensive Income (Loss).

Comparative Reclassifications

Certain amounts from fiscal 2013 have been reclassified to conform to the August 31, 2014 financial statement presentation. The reclassifications related to a change in the presentation of discontinued operations (see Note 4).

3. EFFECTS OF RECENT ACCOUNTING PRONOUNCEMENTS

Recently Issued Accounting Pronouncements

In February 2013, the FASB issued guidance which requires entities to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, entities are required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under GAAP to be reclassified in their entirety to net income, entities are required to cross-reference to other disclosures required under GAAP that provide additional detail on these amounts. This standard is effective prospectively for reporting periods beginning after December 15, 2013. The Company adopted this standard in the quarter ended May 31, 2014, which did not have a material impact on its consolidated financial statements.

 

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In July 2013, the FASB issued guidance which states that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The Company adopted this standard in the quarter ended May 31, 2014, which did not have a material impact on its consolidated financial statements.

In May 2014, the FASB issued guidance which affects any entity using GAAP that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g., insurance contracts or lease contracts). The new guidance will supersede the existing revenue recognition requirements, and most industry-specific guidance. For a public entity, the amendments in this guidance are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early application is not permitted. The guidance permits companies to either apply the requirements retrospectively to all prior periods presented or apply the requirements in the year of adoption, through a cumulative adjustment. The Company has not yet selected a transition method nor has it determined the impact of adoption on its condensed consolidated financial statements.

4. DISCONTINUED OPERATIONS

a) Data Bus

On July 5, 2013, the Company entered into the APA with Parent and the Purchaser, pursuant to which the Company sold to the Purchaser certain assets comprising the Company’s Data Bus business in the U.S. and the U.K., including substantially all of the assets of the Company’s wholly owned subsidiary, National Hybrid, Inc., a New York corporation. The Purchaser paid the Company approximately $32,150 in cash for the assets, after certain adjustments based on closing inventory values as set forth in the APA and customary indemnification provisions.

The operating results of Data Bus are summarized as follows:

 

		(in thousands)
		Three months ended August 31, 2013				Nine months ended August 31, 2013
Revenue, net		$	991			$	7,571
Cost of revenues			547				4,435
Gross Profit			444				3,136
General and administrative			56				484
Selling expenses			2				82
Research and development			—				—
Restructuring			—				—
Provision for income taxes			(375	)			344
Provision for income taxes—Gain on sale of Data Bus			5,293				5,293
Other expenses (income)			(10,002	)			(10,002	)
Income from discontinued operations, net of tax		$	5,470			$	6,935

Other income in the three and nine months ended August 31, 2013 primarily relates to the gain on sale of Data Bus, net of approximately $705 transaction expenses and deferred revenue of $2,544. The Company had a transition services agreement with the Purchaser, where the Company manufactured products in the United States for a period of up to 12 months and could manufacture certain products in the United Kingdom for a period of up to 4 years. The Company determined that the U.K. transition services agreement does not result in the Company having a significant continuing involvement in these discontinued operations following the assessment period.

b) Sensors

On April 17, 2013 the Company sold all of the issued and outstanding shares of capital stock or other equity interests of the Sensors companies for gross cash proceeds of approximately $51,350. Of this amount, $1,500 was previously placed into an escrow account for 12 months to secure any indemnification claims made by the purchaser against the sellers, API and Spectrum.

 

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The operating results of Sensors are summarized as follows:

 

		(in thousands)
		Three months ended August 31, 2013				Nine months ended August 31, 2013
Revenue, net		$	—			$	9,270
Cost of revenues			—				7,155
Gross Profit			—				2,115
General and administrative			—				366
Selling expenses			—				497
Research and development			—				180
Provision for income taxes			—				66
Provision for income taxes—Gain on sale of Sensors			—				1,670
Other expenses (income)			165				(11,814	)
Income (loss) from discontinued operations, net of tax		$	(165	)		$	11,150

Other income in the nine months ended August 31, 2013 primarily relates to the gain on sale of Sensors, net of approximately $2,131 transaction expenses and deferred revenue of $1,780. Pursuant to a transition services agreement, the Company manufactured products for a period of up to 9 months and provided certain administrative services to the purchaser over a period of up to 18 months. The Company determined that the transition services agreement does not result in the Company having a significant continuing involvement in these discontinued operations following the assessment period.

5. FAIR VALUE MEASUREMENTS

The following table summarizes assets and liabilities, which have been accounted for at fair value, along with the basis for the determination of fair value.

 

		(in thousands)
		August 31, 2014												November 30, 2013
		2014 Total				Unobservable Measurement Criteria (Level 3)				Impairment				2013 Total				Unobservable Measurement Criteria (Level 3)				Impairment
Fixed assets held for sale		$	150			$	150			$	—			$	150			$	150			$	—
Derivative liabilities—Redeemable Preferred Stock (Note 10)			—				—				—				(179	)			(179	)			—
Total		$	150			$	150			$	—			$	(29	)		$	(29	)		$	—

The following is a summary of activity for the nine months ended August 31, 2014 and year ended November 30, 2013 for assets and liabilities measured at fair value based on unobservable measure criteria:

 

		(in thousands)
		Fixed Assets Held for Sale				Derivative Liabilities— Preferred Stock
Balance, November 30, 2012		$	900			$	(267	)
Less: Fixed assets sold			(750	)			—
Less: Adjustment to fair value of derivative liabilities			—				88
Balance, November 30, 2013		$	150			$	(179	)
Less: Redemption of Preferred Stock			—				179
Balance, August 31, 2014		$	150			$	—

The fair value of the fixed assets held for sale was determined using a market approach by using prices and other relevant information generated by market transactions involving comparable assets. The Series A Preferred Stock (Note 10) contained an embedded feature for a default dividend rate. The Company determined the fair value of the derivative liabilities related to the preferred stock by using the present value of probability weighted cash flow scenarios. The Series A Preferred Stock was redeemed in March 2014.

 

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6. INVENTORIES

Inventories consisted of the following:

 

		(in thousands)
		August 31, 2014				November 30, 2013
Raw materials		$	24,831			$	26,015
Work in progress			20,185				23,425
Finished goods			9,593				8,778
Total		$	54,609			$	58,218

Inventories are presented net of valuation allowances.

7. SHORT-TERM DEBT

The Company has a credit facility in place for certain of its U.K. subsidiaries for approximately $415 (250 GBP), which renews in July 2015. This line of credit is tied to the prime rate in the United Kingdom and is secured by the U.K. subsidiaries’ assets. This facility was undrawn as of August 31, 2014 and November 30, 2013.

8. ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses consisted of the following:

 

		(in thousands)
		August 31, 2014				November 30, 2013
Trade accounts payable		$	17,743			$	20,714
Accrued expenses			6,570				6,586
Wage and vacation accrual			3,226				4,917
Total		$	27,539			$	32,217

9. LONG-TERM DEBT

The Company had the following long-term debt obligations:

 

		(in thousands)
		August 31, 2014				November 30, 2013
Term loans, due February 6, 2018, base rate plus 6.50% interest or LIBOR plus 7.50%, (a)		$	123,372			$	86,810
Asset based loans, due February 6, 2018, base rate plus a margin between 1.50% and 2.00%, or LIBOR plus a margin between 2.50% and 3.00%, (a)			—				24,345
Mortgage loan, due 2027, 1.35% above Barclays fixed bank rate (b)			1,246				1,318
Note payable—RTIE acquisition (c)			—				139
Capital leases payable (d)			5,446				249
		$	130,064			$	112,861
Less: Current portion of long-term debt			(9,286	)			(8,155	)
Discount and deferred financing charges on term loans			—				(8,100	)
Long-term portion		$	120,778			$	96,606

 

a)

On February 6, 2013, the Company refinanced its credit facilities and entered into (i) a credit agreement (the “Term Loan Agreement”) with various lenders and Guggenheim Corporate Funding, LLC, as agent (the “Agent”) that provides for a $165,000 term loan facility and (ii) a credit agreement with various lenders and Wells Fargo Bank, National Association (the “Revolving Loan Agreement”) that provides for a $50,000 asset-based revolving borrowing base credit facility, with a $10,000 subfacility (or the Sterling equivalent) for certain of our United Kingdom subsidiaries, a $10,000 subfacility for letters of credit and a $5,000 subfacility for swingline loans.

 

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On February 6, 2013, in connection with entering into the Term Loan Agreement and the Revolving Loan Agreement, the Amended and Restated Credit Agreement, dated as of June 27, 2011 and amended on January 6, 2012 and March 22, 2012, by and among the lenders from time to time party thereto and Morgan Stanley Senior Funding, Inc., as administrative agent, lead arranger and sole book-runner, which had an outstanding balance of $183,400 was paid off and terminated, which resulted in the write-off of approximately $10,300 of deferred financing costs and note discounts.

On December 31, 2013, the Company repaid $14,200 of its term loans from the proceeds of the Sale/Leaseback, (see d) below) of the Company’s facility located in State College, Pennsylvania. On July 5, 2013 and April 17, 2013, the Company sold Data Bus and Sensors (Note 4) and repaid approximately $28,780 and $44,919, respectively, of its term loans from the proceeds of these sales, in accordance with the Term Loan Agreement. In addition, the Company repaid a portion of its term loans using the net proceeds of $739 from the March 14, 2013, sale of certain land and a building in Palm Bay, Florida.

On May 22, 2013, the Company entered into a First Amendment to the Revolving Loan Agreement that amends certain cash management and reporting requirements.

On October 10, 2013, the Company entered into an Amendment No. 1 to Credit Agreement (the “Amendment No. 1”). Amendment No. 1, among other things, amends the Term Loan Agreement to reduce the minimum interest coverage ratio, increase the maximum leverage ratio, reduce the interest rate on the term loans and modify the terms of the prepayment premium, which the Company is required to pay upon voluntary prepayments or certain mandatory prepayments of the term loans.

On March 21, 2014, the Company entered into Amendment No. 2 to Credit Agreement (the “Amendment No. 2”), by and among the Company, as borrower, the lenders party thereto and the Agent.

Amendment No. 2 amends the Term Loan Agreement to provide for an incremental term loan facility in an aggregate principal amount equal to $55,000 (the “Incremental Term Loan Facility”), which Incremental Term Loan Facility is subject to substantially the same terms and conditions, including the applicable interest rate and the maturity date of February 6, 2018, as the $165,000 term loan facility provided upon the initial closing of the Term Loan Agreement. In addition, Amendment No. 2 amends the Term Loan Agreement to reduce the minimum interest coverage ratio and increase the maximum leverage ratio, among other things.

The proceeds of the Incremental Term Loan Facility were used (i) to pay in full and terminate the Company’s Revolving Loan Agreement; (ii) to redeem all 26,000 shares of the Company’s Series A Preferred Stock that were outstanding (as defined and described in Note 10); (iii) to pay fees, costs and expenses associated with the Incremental Term Loan Facility and related transactions; and (iv) for general corporate purposes. This resulted in the write-off of approximately $10,212 of deferred financing costs and note discounts in the quarter ended May 31, 2014.

As of August 31, 2014, $123,372 was outstanding under the Term Loan Agreement.

Term Loan Agreement

The term loans incurred pursuant to the Term Loan Agreement, as amended, bear interest, at the Company’s option, at the base rate plus 6.50% or an adjusted LIBOR rate (based on one, two or three-month interest periods) plus 7.50% for the first year and at the base rate plus 7.50% or an adjusted LIBOR rate (based on one, two or three-month interest periods) plus 10.75% thereafter, with a LIBOR floor of 1.50%. For purposes of the Term Loan Agreement, the “base rate” means the highest of Wells Fargo Bank, National Association’s prime rate, the federal funds rate plus a margin equal to 0.50% and the adjusted LIBOR rate for a 3-month interest period plus a margin equal to 1.00%.

Interest is due and payable in arrears monthly for term loans bearing interest at the base rate and at the end of an interest period (or at each three month interval in the case of term loans with interest periods greater than three months) in the case of term loans bearing interest at the adjusted LIBOR rate. Principal payments of the term loans are paid at the end of each of the Company’s fiscal quarters, commencing for the fiscal quarter ending May 31, 2013, with the balance of any outstanding term loans due and payable in full on February 6, 2018. The quarterly principal payments will amortize at 1.25% for the fiscal quarters through the end of the Company’s 2014 fiscal year, at 1.875% for the fiscal quarters through the end of the Company’s 2015 fiscal year and at 2.50% for each of the fiscal quarters thereafter.

Under certain circumstances, we are required to prepay the term loans upon the receipt of cash proceeds of certain asset sales, cash proceeds of certain extraordinary receipts and cash proceeds of certain debt or equity financings, and based on a calculation of annual excess cash flow. Mandatory prepayments resulting from assets sales or certain debt financings may require the payment of certain prepayment premiums.

The term loans are secured by a first priority security interest in accounts receivable, inventory, machinery, equipment and certain other personal property relating to the foregoing, and any proceeds from any of the foregoing, subject to certain exceptions and liens, and a first priority security position on substantially all other real and personal property, in each case that are owned by the Company and the subsidiary guarantors.

 

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Revolving Loan Agreement

The revolving loans incurred pursuant to the Revolving Loan Agreement bore interest, at the Company’s option, at the base rate plus a margin between 1.50% and 2.00% or an adjusted LIBOR rate (based on one, two, three or six-month interest periods) plus a margin between 2.50% and 3.00%, in each case with such margin being determined based on the Company’s average daily excess availability under the revolving credit facility for the preceding fiscal quarter. For purposes of the Revolving Loan Agreement, the “base rate” means the highest of Wells Fargo Bank, National Association’s prime rate, the federal funds rate plus a margin equal to 0.50% and the adjusted LIBOR rate for a 3-month interest period plus a margin equal to 1.00%.

Interest was due and payable in arrears monthly for revolving loans bearing interest at the base rate and at the end of an interest period (or at each three month interval in the case of loans with interest periods greater than three months) in the case of revolving loans bearing interest at the adjusted LIBOR rate. Principal, together with all accrued and unpaid interest, was due and payable on February 6, 2018. The Company was permitted to prepay the revolving loans and terminate the commitments, in whole or in part, at any time without premium or penalty. Under certain circumstances, the Company was required to prepay the revolving loans upon the receipt of cash proceeds of certain asset sales.

All borrowings under the Revolving Loan Agreement were limited by amounts available pursuant to a borrowing base calculation, which was based on percentages of eligible accounts receivable, inventory, machinery and equipment, in each case subject to reductions for applicable reserves.

The Revolving Loan Agreement contained customary affirmative and negative covenants, including covenants that limited or restricted the Company and its subsidiaries’ ability to, among other things, incur indebtedness, grant liens, dispose of assets and pay dividends or make distributions to stockholders, in each case subject to customary exceptions for a credit facility of this size and type.

Pursuant to the Revolving Loan Agreement, the Company was also required to maintain compliance with a fixed charge coverage ratio and to limit its annual capital expenditures to $4,000 per fiscal year (subject to carry-over rights) at such times that it failed to maintain excess availability under the revolving credit facility above a specified level.

On March 21, 2014, approximately $25,136 of the proceeds of the Incremental Term Loan Facility were used to pay in full and terminate the Company’s Revolving Loan Agreement.

 

b)	A subsidiary of the Company in the United Kingdom entered into a 20 year term mortgage agreement in 2007, under which interest is charged at a margin of 1.35% over Barclays Fixed Base Rate of 0.5% at August 31, 2014. The mortgage is secured by the subsidiary’s assets.

c)

On March 19, 2012 the Company completed the acquisition of substantially all of the assets of RTIE Electronics for a total purchase price of $2,295, with $1,500 payable in cash at closing and the remainder pursuant to a $795 Promissory Note payable in 24 equal monthly installments. This Promissory Note payable was fully repaid as of August 31, 2014.

d)

On December 31, 2013, the Company completed the Sale/Leaseback. The Company sold the facility to an unaffiliated third party for a gross purchase price of approximately $15,500 and will lease the property from the buyer for 15 years for approximately $1,279 per year, subject to annual adjustments. As a result of this transaction the Company initially recorded a capital lease obligation of $5,225. The gain on the sale has been deferred and is being recognized over the 15 year lease term.

10. REDEEMABLE PREFERRED STOCK

On March 22, 2012, following the acquisition of C-MAC Aerospace Limited (“C-MAC”), the Company entered into a Note Purchase Agreement by and among the Company and the purchaser referred to therein (the “Note Purchase Agreement”). Pursuant to the Note Purchase Agreement, the Company sold an aggregate initial principal amount of $26,000 of convertible subordinated notes (the “Note”) to a single purchaser in a private placement exempt from the registration requirements of the Securities Act of 1933, as amended. The Company received aggregate gross proceeds of $16,000 from the private placement, all of which will be used for working capital purposes. The purchaser of the Note is an affiliate of Senator Investment Group LP. At the time of the issuance of the Note, the purchaser of the Note was the beneficial owner of approximately 10.7% of our outstanding common stock, without giving effect to the transactions contemplated by the Note Purchase Agreement.

Upon the filing of the amendment to the Charter and the Certificate of Designation (as described and defined below), the Note converted into 26,000 shares of Series A Mandatorily Redeemable Preferred Stock of API (“Series A Preferred Stock”). The holder had the option to convert all or any portion of the amount of the liquidation preference (“Liquidation Preference”) (initially $1,000 per share and $1,058 per share as of February 28, 2014) of the Series A Preferred Stock plus the amount of unpaid and accrued dividends into common stock of API at $6.00 per share.

On March 22, 2012, certain stockholders of the Company took action by written consent (the “Written Consent”), as permitted pursuant to the Company’s bylaws and Amended and Restated Certificate of Incorporation, as amended (the “Charter”), to amend the

 

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Charter to (i) increase the number of shares of common stock, par value $0.001 per share, issuable by the Company to 250,000,000 shares from 100,000,000 shares; and (ii) authorize the issuance by the Company’s Board of Directors, from time to time, of up to 10,000,000 shares of preferred stock, par value $0.001 per share (the “Preferred Stock”), in one or more series. The Written Consent also approved the issuance of shares of API common stock in connection with the conversion of the Note and Series A Preferred Stock as contemplated by the Note Purchase Agreement for all purposes, including pursuant to the rules and regulations of The NASDAQ Stock Market.

On March 22, 2012, subject to the effectiveness of the amendments to the Charter described above, the Company’s Board of Directors also authorized the creation of a class of Preferred Stock designated as “Series A Mandatorily Redeemable Preferred Stock” pursuant to a Certificate of Designation (the “Certificate of Designation”).

The Company received aggregate gross proceeds of $16,000 from the issuance of the Note. The Company recorded a debt discount of $10,000 representing the difference between the principal amount of the Note and the proceeds received. The Note contained embedded features for a default interest rate and make whole provisions. Accordingly, the Company evaluated these embedded features and recorded an additional debt discount in the amount of $588. The Company also recorded $2,272 of additional discount resulting from the beneficial conversion feature of the Notes. The total debt discount was amortized over the contracted life of the Notes using the effective interest method. Up to the date of conversion this resulted in interest expense of $218.

On May 16, 2012, the Company filed the amendments to the Charter and the Certificate of Designation with the Secretary of State of the State of Delaware, at which time they became effective. Pursuant to the Certificate of Designation, the Company is authorized to issue 1,000,000 shares of Series A Preferred Stock. As described above, the Note converted into 26,000 shares of Series A Preferred Stock.

Upon conversion of the Note, the remaining unamortized discount of $12,644 was recorded as interest expense and the $26,000 face value of the Note was recorded as Series A Preferred Stock.

The Series A Preferred Stock ranked, with respect to dividend rights, redemption rights and rights upon liquidation, dissolution or wind-up (i) senior to the common stock and each other class of capital stock or series of Preferred Stock established by the Board of Directors, the terms of which expressly provided that such class or series ranks junior to the Series A Preferred Stock; (ii) junior to all capital stock or series of Preferred Stock established by the Board, the terms of which expressly provided that such class or series will rank senior to the Series A Preferred Stock; and (iii) on parity with all other classes of capital stock or series of Preferred Stock established by the Board of Directors, the terms of which expressly provided that such class or series will rank on parity with the Series A Preferred Stock.

The holders of Series A Preferred Stock were entitled to vote on all matters voted on by holders of the common stock, voting together as a single class with the other shares entitled to vote. The holders of Series A Preferred Stock had the right to cast the number of votes equal to the total number of votes which could be cast in such vote by a holder of the number of shares of common stock into which the shares of Series A Preferred Stock could be converted.

Commencing on March 22, 2013, holders of Series A Preferred Stock were entitled to receive cumulative dividends on the Liquidation Preference, computed on the basis of a 360-day year of twelve 30-day months at a rate equal to 6% per annum, compounded quarterly on the last day of each March, June, September and December. Accrued and unpaid dividends also would have had to been paid on the date of any redemption or on any liquidation, dissolution or winding-up of the Company. Dividends were paid in kind each quarter, by adding the amount of the accrued and unpaid dividend to the Liquidation Preference amount of each share of Series A Preferred Stock (the “Accreted Dividend Amount”). The Accreted Dividend Amount constituted part of the Liquidation Preference of each share of Series A Preferred Stock as of each applicable quarterly dividend payment date and dividends began to accrue on each Accreted Dividend Amount beginning on the date on which such amount was added to the Liquidation Preference amount of each share of Series A Preferred Stock. However, all dividends due and payable on the date that the Liquidation Preference of a share of Series A Preferred Stock became due and payable would have been payable in cash on such date. Upon an Early Redemption Event, dividends would accrue while such event was continuing at the rate equal to the rate for the most recently issued actively traded ten year U.S. Treasury security, plus 10.0%. An “Early Redemption Event” meant if (a) the Company (i) defaulted in its obligation to pay the amounts in connection with a redemption of the Series A Preferred Stock and such default continues unremedied for three business days; (ii) breached in material respect any of its representations or warranties contained in the Note Purchase Agreement, the Note or other document delivered in connection therewith; (iii) breached certain covenants under the Note Purchase Agreement or other document delivered in connection therewith (subject to applicable grace periods); (iv) defaulted (A) in any payment of any indebtedness in excess of $5,500 or (B) defaulted in the observance of any condition or agreement in respect of any such indebtedness, and as a consequence of such default, such indebtedness would become due and payable prior to its stated maturity; (v) commenced certain bankruptcy or similar proceedings or had a bankruptcy or similar proceeding commenced against it that was not dismissed within the applicable grace period; or (b) a material provision of the Note Purchase Agreement, the Note or other agreement delivered in connection therewith ceased to be effective.

 

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The Series A Preferred Stock would have been convertible at any time at the discretion of the holders into that number of shares of common stock equal to the Liquidation Preference being converted (plus any accrued dividends that have not yet been accreted to the Liquidation Preference), divided by the initial conversion price of $6.00 per share, which initial conversion price was subject to adjustments as described below. In addition, upon a Change of Control (as defined in the Note Purchase Agreement), the sale of all or substantially all of the assets of the Company or the occurrence of certain dilution events (a “Mandatory Redemption Event”), then the holders of Series A Preferred Stock would have had the right to receive upon conversion, in lieu of the common stock otherwise issuable, such shares of stock, securities or other property as would have been issued or payable upon such Mandatory Redemption Event had the shares of Series A Preferred Stock been converted into common stock immediately prior to such Mandatory Redemption Event.

On or before March 22, 2019, all of the outstanding shares of Series A Preferred Stock were to be redeemed by the Company for the amount of the Liquidation Preference, plus any and all amounts owing to the holder of such redeemed shares pursuant to the terms of the Note Purchase Agreement, the Note or any other document delivered in connection therewith. The Company was required to offer to redeem all of the shares of Series A Preferred Stock upon a Mandatory Redemption Event. A holder of Series A Mandatorily Redeemable Preferred Stock could have accepted or rejected such offer of redemption.

The Company, as of March 21, 2014, redeemed all 26,000 shares of its outstanding Series A Preferred Stock. The Company paid the holder of the Series A Preferred Stock an aggregate of $27,600 to effect the redemption. This resulted in a gain of $549, which is recorded in Other expenses (income) on the Consolidated Statement of Operations. Following the redemption, all shares of Series A Preferred Stock were cancelled and such shares were returned to authorized but undesignated shares of the Company’s preferred stock.

11. SHAREHOLDERS’ EQUITY

On January 20, 2010 the Company agreed to issue 800,000 shares of API common stock payable as part of the compensation to Kuchera Defense Systems, Inc. (“KDS”), KII, Inc. (“KII”) and Kuchera Industries, LLC (“KI Industries” and collectively with KDS and KII, the “KGC Companies”) or their designees. 250,000 shares were issued and delivered at closing, 250,000 shares were to be issued and delivered on the first anniversary of the closing and 300,000 shares were to be issued and delivered on the second anniversary of the closing. The Company has issued 126,250 shares in escrow from the remaining 550,000 shares. Three API subsidiaries have claimed a right of set off against the escrowed shares under the asset purchase agreement with respect to claimed amounts due to the Company under the indemnification provisions of the asset purchase agreement. The unissued shares have been accounted for as common shares subscribed but not issued. In addition, on January 20, 2010 and January 22, 2010, we issued warrants to purchase an aggregate of 892,862 shares of common stock with an exercise price of $5.60 per share, which expire on January 20, 2015 and January 22, 2015.

In connection with the Plan of Arrangement that occurred on November 6, 2006, the Company was obligated to issue 2,354,505 shares of either API common stock or exchangeable shares of API Nanotronics Sub, Inc. in exchange for the API Electronics Group Corp. common shares previously outstanding. As of August 31, 2014, API is obligated to issue a remaining approximately 63,886 shares of its common stock under the Plan of Arrangement either directly for API common shares or in exchange for API Nanotronics Sub, Inc. exchangeable shares not held by API or its affiliates. There are 22,617 exchangeable shares outstanding (excluding exchangeable shares held by the Company) as of August 31, 2014. Exchangeable shares are substantially equivalent to our common shares.

The Company issued 245,000 options and 15,000 RSUs during the nine months ended August 31, 2014 and 15,000 RSUs during the nine months ended August 31, 2013 (Note 12). The Company values its option grants using the Black-Scholes option-pricing model.

12. STOCK-BASED COMPENSATION

On October 26, 2006, the Company adopted its 2006 Equity Incentive Plan (the “Equity Incentive Plan”), which was approved at the 2007 Annual Meeting of Stockholders of the Company. All the prior options issued by API were carried over to this plan under the provisions of the Plan of Arrangement. On October 22, 2009, the Company amended the Equity Incentive Plan to increase the number of shares of common stock under the plan from 1,250,000 to 2,125,000. On January 21, 2011, the Company amended the Equity Incentive Plan to further increase the number of shares of common stock under the plan from 2,125,000 to 5,875,000, and on June 3, 2011 amended the plan to permit the issuance of RSUs, which amendments were approved by the shareholders of the Company on November 4, 2011. Of the 5,875,000 shares authorized under the Equity Incentive Plan, 3,580,864 shares are available for issuance pursuant to options, RSUs, or stock as of August 31, 2014. Under the Company’s Equity Incentive Plan, incentive options and non-statutory options may have a term of up to ten years from the date of grant. The stock option exercise prices are equal to at least 100 percent of the fair market value of the underlying shares on the date the options are granted.

 

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As of August 31, 2014 there was $374 of total unrecognized compensation related to non-vested stock options, which are not contingent upon attainment of certain milestones. For options with certain milestones necessary for vesting, the fair value is not calculated until the conditions become probable. The cost is expected to be recognized over the remaining periods of the options, which are expected to vest from 2014 to 2017.

During the nine months ended August 31, 2014 and 2013, ($99) and $791, respectively, has been recognized as stock-based compensation expense in general and administrative expense.

The fair value of each option grant is estimated at the grant date using the Black-Scholes option-pricing model based on the weighted average assumptions detailed below:

 

		August 31, 2014				August 31, 2013
Expected volatility			70.2	%			81.9	%
Expected dividends			0	%			0	%
Expected term			6 years				6 years
Risk-free rate			1.58	%			0.85	%

The summary of the common stock options granted, cancelled, exchanged or exercised under the Plan:

 

		Options				Weighted Average Exercise Price
Stock Options outstanding—November 30, 2012			2,417,606			$	5.06
Less forfeited			(569,121	)		$	5.26
Exercised			—			$	—
Issued			—			$	—
Stock Options outstanding—November 30, 2013			1,848,485			$	4.98
Less forfeited			(606,650	)		$	5.24
Exercised			—			$	—
Issued			245,000			$	2.23
Stock Options outstanding—August 31, 2014			1,486,835			$	4.43
Stock Options exercisable—August 31, 2014			1,078,410			$	5.04

Restricted stock unit activity under the 2006 Equity Compensation Plan is presented below:

 

		Units				Weighted Average Grant Date Fair Value
RSUs outstanding—November 30, 2012			139,000			$	4.43
Issued			15,000			$	2.56
Exercised—Stock issued			(72,333	)		$	4.94
RSUs outstanding—November 30, 2013			81,667			$	3.72
Issued			15,000			$	2.37
Exercised—Stock issued			(48,333	)		$	3.72
RSUs outstanding—August 31, 2014			48,334			$	3.30
RSUs exercisable—August 31, 2014			—			$	—

 

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		RSUs and Options Outstanding																RSUs and Options Exercisable
Range of Exercise Price		Number of Outstanding at August 31, 2014				Weighted Average Exercise Price				Weighted Average Remaining Life (Years)				Aggregate Intrinsic Value (in thousands)				Number Exercisable at August 31, 2014				Weighted Average Exercise Price				Aggregate Intrinsic Value (in thousands)
$0.00 –$ 3.55			841,667			$	2.93				8.05			$	105				409,991			$	3.49			$	—
$3.56 –$ 4.99			27,084			$	3.56				6.15			$	—				16,251			$	3.56			$	—
$5.00 –$ 6.99			660,584			$	5.95				6.09			$	—				646,334			$	5.97			$	—
$7.00 –$ 20.00			5,834			$	14.07				2.74			$	—				5,834			$	14.07			$	—
			1,535,169								7.15			$	105				1,078,410							$	—

The intrinsic value is calculated as the excess of the market value as of August 31, 2014 over the exercise price of the shares. The market value as of August 31, 2014 was $2.18 as reported by the NASDAQ Stock Market.

13. SUPPLEMENTAL CASH FLOW INFORMATION

Supplemental cash flow information:

 

		(in thousands) Nine months ended
		August 31, 2014				August 31, 2013
Supplemental Cash Flow Information
Cash paid for income taxes		$	683			$	1,348
Cash paid for interest		$	6,253			$	10,974
Capital lease obligation		$	5,225			$	—
Deferred gain on Sale/Leaseback (note 9d)		$	8,532			$	—

In February 2014, the Company received $1,414 related to a tax refund from the acquisition of one of its subsidiaries, SenDEC Corporation.

14. EARNINGS PER SHARE OF COMMON STOCK

The following table sets forth the computation of weighted-average shares outstanding for calculating basic and diluted earnings per share (EPS):

 

Three months ended

Nine months ended

August 31, 2014

August 31, 2013

August 31, 2014

August 31, 2013

Weighted average shares-basic

55,461,217

55,424,157

55,444,759

55,398,833

Effect of dilutive securities

*

*

*

*

Weighted average shares—diluted

55,461,217

55,424,157

55,444,759

55,398,833

Basic EPS and diluted EPS for the three and nine months ended August 31, 2014 and 2013 have been computed by dividing the net income (loss) by the weighted average shares outstanding. The weighted average numbers of shares of common stock outstanding includes exchangeable shares and shares to be issued under the Plan of Arrangement.

 

*

Outstanding options and RSUs aggregating 1,535,169 incremental shares, and 892,862 warrants have been excluded from the three and nine months ended August 31, 2014 computations of diluted EPS as they are anti-dilutive due to the losses generated in each respective period. Outstanding options and RSUs aggregating 1,972,488 incremental shares, and 892,862 warrants have been excluded from the three and nine months ended August 31, 2013 computations of diluted EPS as none are exercisable and in-the-money.

15. COMMITMENTS AND CONTINGENCIES

 

a)

On September 15, 2011, Currency, Inc., KII Inc., Kuchera Industries, LLC, William Kuchera and Ronald Kuchera (the “Plaintiffs”) filed a lawsuit against API and three API subsidiaries (the “API Pennsylvania Subsidiaries”) in the Court of Chancery of the State of Delaware in relation to the Asset Purchase Agreement by and among API, the API Pennsylvania Subsidiaries, the KGC Companies, William Kuchera, and Ronald Kuchera dated January 20, 2010. Plaintiffs’ complaint alleges claims for breach of contract and unjust enrichment based on their contention that API and the API Pennsylvania Subsidiaries violated the Agreement by failing to issue certain shares of stock to Plaintiffs and by failing to cooperate with

 

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Plaintiffs in the filing of a final general and administrative overhead rate with the Defense Contracting Audit Agency. API and the API Pennsylvania Subsidiaries filed an answer to the complaint denying all liability and a counterclaim for breach of contract against Plaintiffs. The final outcome and impact of this matter is subject to many variables, and cannot be predicted. Of the 550,000 shares that have not been delivered under the Asset Purchase Agreement, 126,250 were placed in escrow and the remaining 423,750 shares have been accounted for as common shares subscribed but not issued with a value of $2,373.

 

b)

The Company is also a party to lawsuits in the normal course of its business. Litigation can be unforeseeable, expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on the Company’s business, operating results, or financial condition.

In accordance with required guidance, the Company accrues for litigation matters when losses become probable and reasonably estimable. The Company has no recorded accrual relating to its outstanding legal matters as of August 31, 2014 and November 30, 2013. As of the end of each applicable reporting period, or more frequently, as necessary, the Company reviews each outstanding matter and, where it is probable that a liability has been incurred, it accrues for all probable and reasonably estimable losses. Where the Company is able to reasonably estimate a range of losses with respect to such a matter, it records an accrual for the amount within the range that constitutes its best estimate. If the Company can reasonably estimate a range but no amount within the range appears to be a better estimate than any other, it will use the amount that is the low end of such range. Because of the uncertainty, the complexity and the many variables involved in litigation, the actual costs to the Company with respect to its legal matters may differ from our estimates, could result in a significant difference and could have a material adverse effect on the Company’s financial position, liquidity, or results of operations. If we determine that an additional loss in excess of our accrual is probable but not estimable, the Company will provide disclosure to that effect. The Company expenses legal costs as they are incurred.

16. INCOME TAXES

For the three and nine month periods ended August 31, 2014, the Company’s effective income tax rates were (5.0 )% and (4.1)% for continuing operations, respectively and 212.2% and 15.5% for the three and nine months ended August 31, 2013, respectively, compared to an applicable U.S. federal statutory income tax rate of 34%. The difference between the effective tax rate and U.S. statutory tax as of August 31, 2014 is primarily due to the existence of valuation allowances for deferred tax assets including net operating losses and income from foreign subsidiaries taxed at rates lower than the U.S. statutory rate. For the nine months ended August 31, 2014, the Company recorded valuation allowances on deferred tax assets relating to current year losses and for the accrual of non-cash tax expense due to additional valuation allowances in connection with the tax amortization of our indefinite-lived intangible assets that was not available to offset existing deferred tax assets. The difference between the effective tax rate and U.S. statutory tax as of August 31, 2013 is primarily due to existence of valuation allowance for deferred tax assets including net operating losses and income from foreign subsidiaries taxed at rates lower than the U.S. statutory rate. During the quarter ended August 31, 2014, the Company implemented a tax planning strategy in Canada that will allow it to utilize deferred tax assets that were previously subject to a valuation allowance.

As of August 31, 2014, the Company has no significant unrecognized tax benefits.

The Company records interest and penalties related to tax matters within general and administrative expenses on the accompanying Consolidated Statement of Operations. These amounts are not material to the consolidated financial statements for the periods presented. The Company’s U.S. tax returns are subject to examination by federal and state taxing authorities. Generally, tax years 2010 through 2013 remain open to examination by the Internal Revenue Service or other tax jurisdictions to which the Company is subject. The Company’s Canadian tax returns are subject to examination by federal and provincial taxing authorities in Canada. Generally, tax years 2010 through 2013 remain open to examination by Canada Revenue Agency or other tax jurisdictions to which the Company is subject.

17. RESTRUCTURING CHARGES RELATED TO CONSOLIDATION OF OPERATIONS

In accordance with accounting guidance for costs associated with asset exit or disposal activities, restructuring costs are recorded as incurred. Restructuring charges for employee workforce reductions are recorded upon employee notification.

a) Ottawa restructuring

In November 2013, the Company commenced the restructuring of its Ottawa, Ontario, Canada business (“Ottawa restructuring”), which included the movement of certain operations to its State College facility, in order to improve its profitability. The actions taken as part of the Ottawa restructuring are intended to realize synergies from our combined SSC operations, contain costs and streamline our operations. Elements of the Ottawa restructuring include management re-alignment, workforce reductions and write-downs and charges related to inventory and relocation costs. The Ottawa restructuring was substantially completed by May 31, 2014. As a result of the Ottawa restructuring, the Company reduced its SSC workforce by approximately 4%, which represents approximately 3% of its global workforce.

 

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The Company has recorded $1,560 of salary and related charges for the Ottawa restructuring. As of August 31, 2014, $566 is included in accounts payable and accrued liabilities.

b) EMS restructuring

In June 2012, the Company announced the restructuring of its EMS business (“EMS restructuring”) in order to improve its profitability. The actions taken as part of the EMS restructuring are intended to realize synergies from our combined EMS operations, contain costs, reduce our exposure to low margin and unprofitable revenue streams within the EMS businesses, and streamline our operations. Elements of the EMS restructuring include management re-alignment, workforce reductions and write-downs and charges related to inventory, fixed assets, and long-term leases. The EMS restructuring was substantially completed by the end of fiscal 2012. As of November 30, 2012, the Company reduced its EMS workforce by approximately 10%, which represented approximately 2% of its global workforce.

During the period ending November 30, 2012, the Company incurred approximately $591 related to cash outlays, primarily due to employee separation expense. The majority of the non-cash charges are primarily related to the write-down of inventory related to the EMS product offerings, leasehold impairments and fixed asset impairments.

The following tables summarize the charges related to EMS restructuring activities by type of cost:

 

		EMS Restructuring (in thousands)
Salary and related charges		$	591
Inventory write-down			7,401
Fixed asset impairment			865
Lease impairment			3,672
Accumulated restructuring charges at November 30, 2012			12,529
Cash payments			(591	)
Non-cash charges			(9,760	)
Balance—Lease impairment accrual, August 31, 2014		$	2,178

18. SEGMENT INFORMATION

The Company follows the authoritative guidance on the required disclosures for segments which establish standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in financial reports. The guidance also establishes standards for related disclosures about products, geographic areas and major customers.

The authoritative accounting guidance uses a management approach for determining segments. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company’s reportable segments. The Company’s operations are conducted in three principal business segments: Systems, Subsystems & Components (SSC), Secure Systems & Information Assurance (SSIA) and Electronic Manufacturing Services (EMS). Inter-segment sales are presented at their market value for disclosure purposes. Corporate includes general and administrative functions and unallocated costs of our shared service operations/management, administrative and other shared corporate services functions such as information technology, legal, finance, human resources, and marketing. These administrative and other shared services costs have been allocated in the adjusted EBITDA measure based on a percent of revenue for each respective operating segment.

During the quarter ended February 28, 2014, the Company changed its reported basis of measurement of segment profit or loss. This change in reporting has been applied to the quarter and nine months ended August 31, 2014 and 2013. The Company’s chief operating decision maker evaluates segment performance based primarily on revenues and Adjusted EBITDA. The accounting policies of each of the operating segments are the same as those described in the summary of significant accounting policies in Note 2. Adjusted EBITDA represents income from continuing operations excluding depreciation and amortization, stock-based compensation expense and other items as described below. Management views adjusted EBITDA as an important measure of segment performance because it removes from operating results the impact of items that management believes do not reflect the Company’s core operating performance. Adjusted EBITDA is a measure which is also used in calculating financial ratios in material debt covenants in the Company’s credit facilities.

 

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Management does not evaluate the performance of its operating segments using asset measures. The identifiable assets by segment disclosed in this note are those assets specifically identifiable within each segment and include cash, accounts receivable, inventory, goodwill and intangible assets.

 

 

Three months ended August 31, 2014 (in thousands)		SSC				SSIA				EMS				Corporate				Inter Segment Eliminations				Total
Revenue from external customers		$	41,877			$	6,230			$	8,817			$	—			$	—			$	56,924
Adjusted EBITDA:			7,133				1,014				(388	)			—				—				7,759
Acquisition related charges																							190
Restructuring																							497
Depreciation and amortization																							4,029
Interest expense, net																							3,289
Amortization of note discounts and deferred financing costs																							24
Other adjustments *																							334
Loss from continuing operations before income taxes																						$	(604	)
Segment assets—as at August 31, 2014		$	244,337			$	13,983			$	23,931			$	6,403			$	—			$	288,654
Goodwill included in assets—as at August 31, 2014		$	114,301			$	—			$	2,469			$	—			$	—			$	116,770
Purchase of fixed assets, to August 31, 2014		$	593			$	83			$	76			$	—			$	—			$	752

 

Three months ended August 31, 2013 (in thousands)		SSC				SSIA				EMS				Corporate				Inter Segment Eliminations				Total
Revenue from external customers		$	45,653			$	3,712			$	13,265			$	—			$	—			$	62,630
Adjusted EBITDA:			7,474				627				252				—				—				8,353
Acquisition related charges																							(111	)
Restructuring charges																							136
Depreciation and amortization																							4,605
Interest expense, net																							3,086
Amortization of note discounts and deferred financing costs																							521
Other adjustments *																							1,598
Loss from continuing operations before income taxes																						$	(1,482	)
Segment assets—as at November 30, 2013		$	249,363			$	15,068			$	34,741			$	5,406			$	—			$	304,578
Goodwill included in assets—as at November 30, 2013		$	114,301			$	—			$	2,469			$	—			$	—			$	116,770
Purchase of fixed assets, to August 31, 2013		$	876			$	10			$	68			$	4			$	—			$	958

 

*

Other adjustments primarily include inventory provisions ($425—2014; $787—2013), stock based compensation ($(31)—2014; $191—2013), corporate franchise taxes ($36—2014; $54—2013), financing related costs ($212—2014; $523—2013), foreign exchange losses ($14—2014; $43—2013), and in fiscal 2014 also include lease payments for the State College, Pennsylvania facility ($(322)—2014).

 

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Nine months ended August 31, 2014 (in thousands)		SSC				SSIA				EMS				Corporate				Inter Segment Eliminations				Total
Revenue from external customers		$	120,809			$	16,692			$	31,510			$	—			$	—			$	169,011
Adjusted EBITDA:			16,082				2,624				(171	)			—				—				18,535
Acquisition related charges																							375
Restructuring																							1,945
Depreciation and amortization																							12,269
Interest expense, net																							8,586
Amortization of note discounts and deferred financing costs																							10,916
Other adjustments *																							1,488
Loss from continuing operations before income taxes																						$	(17,044	)
Purchase of fixed assets, to August 31, 2014		$	1,280			$	105			$	213			$	—			$	—			$	1,598

 

Nine months ended August 31, 2013 (in thousands)		SSC				SSIA				EMS				Corporate				Inter Segment Eliminations				Total
Revenue from external customers		$	128,112			$	12,689			$	44,362			$	—			$	—			$	185,163
Adjusted EBITDA:			17,294				2,478				1,053				—				—				20,825
Acquisition related charges																							977
Restructuring charges																							866
Depreciation and amortization																							13,225
Interest expense, net																							11,907
Amortization of note discounts and deferred financing costs																							11,795
Other adjustments *																							3,441
Loss from continuing operations before income taxes																						$	(21,386	)
Purchase of fixed assets, to August 31, 2013		$	1,685			$	33			$	362			$	4			$	—			$	2,084

 

*

Other adjustments primarily include inventory provisions ($1,593—2014; $1,944—2013), stock based compensation ($(99)—2014; $791—2013), corporate franchise taxes ($122—2014; $235—2013), financing related costs ($312—2014; $851—2013), foreign exchange losses ($240—2014; $159—2013), reversal of contingency accrual ($nil—2014; $(539)—2013) and in fiscal 2014 also include lease payments for the State College, Pennsylvania facility ($(862)—2014) and $182 related to change in employee vacation policy.

 

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ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

This section is provided as a supplement to, and should be read in conjunction with, our unaudited Consolidated Financial Statements and accompanying Notes thereto included in this Quarterly Report on Form 10-Q, as well as our Annual Report on Form 10-K for the year ended November 30, 2013 to help provide an understanding of our financial condition, changes in financial condition and results of our operations.

As discussed below, we sold Data Bus and Sensors. The results of Data Bus and Sensors are presented as discontinued operations for all periods presented.

Business Overview of API Technologies Corp.

General

We design, develop and manufacture high reliability RF/microwave, microelectronics, power, and security products and solutions to the defense, aerospace, industrial, satellite, and commercial end markets. In addition, we provide electronics manufacturing services to such markets. We own and operate several state-of-the-art manufacturing facilities in the United States, the United Kingdom, Canada, China and Mexico.

Operating through our three segments, Systems, Subsystems & Components (SSC), Electronic Manufacturing Services (EMS) and Secure Systems & Information Assurance (SSIA), we are positioned as a differentiated solution provider to U.S. and U.S. friendly governments, military, defense, aerospace and homeland security contractors, and leading industrial and commercial firms. With a focus on high-reliability products and solutions, our product portfolio spans RF/microwave and microelectronics, electromagnetics, power products, and security products. We also offer a wide range of electronic manufacturing services from prototyping to high volume production.

On March 21, 2014, we entered into Amendment No. 2 to Credit Agreement (the “Amendment No. 2”), by and among the Company, as borrower, the lenders party thereto and Guggenheim Corporate Funding, LLC, as administrative agent (the “Agent”). Amendment No. 2 amends the Credit Agreement, dated as of February 6, 2013, by and among the Company, as borrower, the lenders party thereto and Agent (as amended, supplemented or modified from time to time, the “Term Loan Agreement”) to provide for an incremental term loan facility in an aggregate principal amount equal to $55.0 million (the “Incremental Term Loan Facility”). The Incremental Term Loan Facility is subject to substantially the same terms and conditions, including the applicable interest rate and the maturity date of February 6, 2018, as the $165.0 million term loan facility provided upon the initial closing of the Term Loan Agreement. In addition, Amendment No. 2 amends the Term Loan Agreement to reduce the minimum interest coverage ratio and increase the maximum leverage ratio, among other things.

The proceeds of the Incremental Term Loan Facility were used (i) to pay in full the amounts due under a Credit Agreement (the “Revolving Loan Agreement”), by and among the Company and certain of its U.S. subsidiaries, as borrowers, the lenders from time to time party thereto and Wells Fargo Bank, National Association, as administrative agent and U.K. security trustee, which Revolving Loan Agreement was then terminated; (ii) to redeem all 26,000 shares of the Company’s Series A Mandatorily Redeemable Preferred Stock that were outstanding (as described below); (iii) to pay fees, costs and expenses associated with the Incremental Term Loan Facility and related transactions; and (iv) for general corporate purposes.

As of March 21, 2014, we redeemed all 26,000 shares of our Series A Mandatorily Redeemable Preferred Stock that were outstanding. We paid the holder of the Series A Mandatorily Redeemable Preferred Stock an aggregate of $27.6 million to effect the redemption. Following redemption, all shares of Series A Mandatorily Redeemable Preferred Stock were cancelled and such shares were returned to authorized but undesignated shares of preferred stock.

On December 31, 2013, we completed the sale and leaseback (the “Sale/Leaseback”) of the Company’s facility located in State College, Pennsylvania. We sold the facility to an unaffiliated third party for a gross purchase price of approximately $15.5 million and will lease the property from the buyer for approximately $1.3 million per year, subject to annual adjustments. We used $14.2 million of the proceeds of the Sale/Leaseback to prepay a portion of our outstanding indebtedness under the Term Loan Agreement.

On July 5, 2013, we entered into an agreement (the “APA”) with ILC Industries, LLC (“Parent”) and Data Device Corporation, a Delaware corporation and a wholly owned subsidiary of Parent (the “Purchaser”) pursuant to which we sold to the Purchaser certain assets comprising the Company’s data bus business (“Data Bus”) in the U.S. and the U.K., including substantially all of the assets of the Company’s wholly owned subsidiary, National Hybrid, Inc., a New York corporation (the “Asset Sale”). The Purchaser paid us approximately $32.2 million in cash for the assets, after certain adjustments based on closing inventory values as set forth in the APA and customary indemnification provisions. Substantially all of the proceeds from the Asset Sale were used to repay certain of our outstanding debt.

 

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On April 17, 2013 we sold all of the issued and outstanding shares of capital stock or other equity interests of Spectrum Sensors and Controls, Inc., a Pennsylvania corporation (“Sub 1”), Spectrum Sensors and Controls, LLC, a California limited liability company (“Sub 2”), and Spectrum Sensors and Controls, Inc., an Ohio corporation (“Sub 3” and together with Sub 1 and Sub 2, “Sensors”), for gross cash proceeds of approximately $51.4 million. Of this amount, $1.5 million was placed into an escrow account for 12 months to secure any indemnification claims made by the purchaser against the sellers, API and Spectrum Control, Inc. (“Spectrum”), a wholly owned subsidiary of API, which was paid in April 2014.

On February 6, 2013, we refinanced substantially all of our indebtedness. We entered into the Term Loan Agreement and the Revolving Loan Agreement, which provided for a $50.0 million revolving borrowing base credit facility, with a $10.0 million subfacility (or the Sterling equivalent) for a revolving borrowing base credit facility that was available to certain of our United Kingdom subsidiaries, a $10.0 million sub-facility for letters of credit and a $5.0 million sub-facility for swingline loans. The proceeds of both loan facilities were used to refinance and pay in full our existing credit facility under a Credit Agreement by and among the lenders from time to time party thereto and Morgan Stanley Senior Funding, Inc., as administrative agent, lead arranger and sole book-runner, to payoff the term loan facility with Lockman Electronics Holdings Limited, and to pay fees, costs and expenses associated with the refinancing. As discussed above, the Revolving Loan Agreement was repaid and terminated in March 2014.

Commencing in 2010, we began various cost reduction initiatives to rationalize the number of our facilities and personnel, which has resulted in us consolidating certain parts of our manufacturing operations. During the year ended November 30, 2013, we also began the consolidation of certain parts of our Ottawa, Canada operations to State College, Pennsylvania. The collective impact of these changes has resulted in a net reduction of costs of approximately $43.9 million on an annualized basis.

Operating Revenues

We derive operating revenues from our three principal business segments: Systems, Subsystems & Components (SSC); Electronic Manufacturing Services (EMS); and Secure Systems & Information Assurance (SSIA). We sell our products to customers throughout the world, with a concentration in North America, western Europe, and the Asia-Pacific region.

Systems, Subsystems & Components (SSC) Revenue includes high-performance RF/microwave, microelectronics, millimeter wave, electromagnetic, power, and microelectronics solutions used in high-reliability defense, space, industrial and commercial applications, including missile systems, radar systems, electronic warfare systems (e.g. counter-IED RF jamming devices), unmanned air, ground and robotic systems, satellites, as well as industrial, medical, energy and telecommunications products. The main demand today for our SSC products come from various world governments, including militaries, defense organizations, commercial aerospace, space, homeland security, prime defense contractors and manufacturers of industrial products.

Electronic Manufacturing Services (EMS) Revenue includes high speed surface mount circuit card assemblies using both surface mount and thru-hole processes, electromechanical assemblies, system and integrated level solutions used in high-reliability defense, industrial, and commercial applications. The main demand today for our EMS products come from various defense organizations, aerospace, prime defense contractors and manufacturers of industrial, medical and commercial products.

Secure Systems & Information Assurance (SSIA) Revenue includes revenues derived from the manufacturing of TEMPEST and Emanation control products, ruggedized computers and peripherals, secure mobile devices, secure access and information assurance products. The principal market for these products are the defense industries of the United States, Canada and the United Kingdom and other U.S. friendly governments, Fortune 500 companies and telecommunication service providers.

 

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Cost of Revenues

We conduct all of our design and manufacturing efforts in the United States, Canada, United Kingdom, Mexico and China. Cost of goods sold primarily consists of costs that were incurred to manufacturer, test and ship the products and some design costs for customer funded research and development (“R&D”). These costs include raw materials, including freight, direct labor, subcontractor services, tooling required to design and build the parts, and the cost of testing (labor and equipment) the products throughout the manufacturing process and final testing before the parts are shipped to the customer. Other costs include provision for obsolete and slow moving inventory, and restructuring charges related to the consolidation of operations.

Operating Expenses

Operating expenses consist of selling, general, administrative expenses, research and development, business acquisition and related charges and other income or expenses.

Selling, General and Administrative Expenses

Selling, general and administrative (“SG&A”) expenses include compensation and benefit costs for all employees, including sales and customer service, sales commissions, executive, finance and human resource personnel. Also included in SG&A is compensation related to stock-based awards to employees and directors, professional services for accounting, legal and tax, information technology, rent and general corporate expenditures.

Research and Development Expenses

R&D expenses represent the cost of our development efforts. R&D expenses include salaries of engineers, technicians and related overhead expenses, the cost of materials utilized in research, and additional engineering or consulting services. R&D costs are expensed as incurred.

Business Acquisition and Related Charges

Business acquisition charges primarily represent costs of engaging outside legal, accounting, due diligence, business valuation consultants and accelerated stock option expenses related to business combinations or divestitures. Related charges include costs incurred related to our efforts to consolidate operations of recently acquired and legacy businesses and expenses associated with divestitures.

Other Expenses (Income)

Other expenses (income) consists of interest expense on term loans, notes payable, operating loans and capital leases, interest income on cash and cash equivalents and marketable securities, amortization of note discounts and deferred financing costs, gains or losses on disposal of property and equipment, and gains or losses on foreign currency transactions. Other income also includes gains related to the sales of fixed assets held for sale and acquisition-related gains when net assets acquired exceed the purchase price of the business acquisition.

Backlog

Our sales backlog at August 31, 2014 was approximately $129.6 million compared to approximately $131.0 million at November 30, 2013. Our backlog figures represent confirmed customer purchase orders that we had not shipped at the time the figures were calculated. We anticipate that approximately $87.1 million of our backlog orders will be filled by August 31, 2015. We lack control over the timing of new purchase orders, as such, the backlog can increase or decrease significantly based on timing of customer purchase orders.

 

		(dollar amounts in thousands)
		August 31, 2014				November 30, 2013				% Change
Backlog by segments:
SSC		$	106,115			$	96,493				10.0	%
EMS			17,909				25,028				(28.4	)%
SSIA			5,544				9,489				(41.6	)%
		$	129,568			$	131,010				(1.1	)%

The decrease at August 31, 2014 compared to November 30, 2013 was related to our EMS and SSIA segments as a result of lower EMS and SSIA bookings due to program timing in the nine months ended August 31, 2014, partially offset by increased SSC bookings in the nine months ended August 31, 2014.

 

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Results of Operations for the Three Months Ended August 31, 2014 and 2013

The following discussion of results of operations is a comparison of our three months ended August 31, 2014 and 2013.

Segment Operating Revenue and Adjusted EBITDA

Financial information for each of our segments is set forth in Part I- Item 1, Financial Statements (unaudited), Note 18 “Segment Information” to our unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q. In deciding how to allocate resources and assess performance, our chief operating decision maker regularly evaluates the performance of our reportable segments on the basis of revenue and adjusted EBITDA. Segment adjusted EBITDA assists us in comparing our segment performance over various reporting periods because it removes from our operating results the impact of items that our management believes do not reflect our core operating performance. Our reportable segment measure of adjusted EBITDA is not a recognized measure under GAAP and should not be considered an alternative to, or more meaningful than, net income (loss) or other measures of financial performance derived in accordance with GAAP. Our segment adjusted EBITDA may not be comparable to similarly titled measures of other companies because other entities may not calculate segment adjusted EBITDA in the same manner.

Our segment Adjusted EBITDA is defined as income from continuing operations before income taxes, interest, depreciation and amortization, and excluding other items. Such items include stock-based compensation expense, non-cash inventory provisions, corporate franchise taxes, acquisition related charges, restructuring charges, financing related costs, foreign exchange losses, reversal of contingency accruals, charges related to changes in employee vacation policy, and lease payments related to the Sale/Leaseback.

 

 

		(dollar amounts in thousands) Three months ended August 31,
		2014				2013				% Change
Revenues by segments:
SSC		$	41,877			$	45,653				(8.3	)%
EMS			8,817				13,265				(33.5	)%
SSIA			6,230				3,712				67.8	%
		$	56,924			$	62,630				(9.1	)%

We recorded a 9.1% decrease in overall revenues for the three months ended August 31, 2014 over the same period in 2013. The decrease was primarily due to lower revenues in our EMS and SSC segments largely due to the completion of TSA agreements and completion of Phase I of an electronic warfare program in the same period in 2013, partially offset by higher revenues in our SSIA segment compared to the three months ended August 31, 2013. During the three months ended August 31, 2014, the decrease in our EMS segment revenues was also due to timing of certain key defense programs and our customer’s new product execution.

 

 

		(dollar amounts in thousands) Three months ended August 31,
		2014				2013				% Change
Segment Adjusted EBITDA:
SSC		$	7,133			$	7,474				(4.6	)%
EMS			(388	)			252				(253.8	)%
SSIA			1,014				627				61.7	%

The SSC segment adjusted EBITDA for the three months ended August 31, 2014 was lower than the comparable period in 2013 primarily due to impact of lower revenues in the quarter ended August 31, 2014 compared to the same period last year, partially offset by improved product mix and increased efficiencies. During the three months ended August 31, 2014, the decrease in our EMS segment adjusted EBITDA was primarily due to lower revenues in the quarter ended August 31, 2014 compared to the same period last year. The SSIA segment has higher adjusted EBITDA compared to the same period last year as a result of higher revenues in the quarter, partially offset by a change in product mix in the quarter ended August 31, 2014, due to the completion of a contract in the quarter ended August 31, 2014 with a low margin profile.

 

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Operating Expenses

Cost of Revenues and Gross Margin

 

		Three months ended August 31,
		2014				2013
Gross margin by segments:
SSC			30.9	%			28.6	%
EMS			1.0	%			4.9	%
SSIA			28.7	%			34.6	%
Overall			26.0	%			23.9	%

Our combined gross margin for the three months ended August 31, 2014 increased by approximately 2.1 percentage points compared to the three months ended August 31, 2013. Gross margin varies from period to period and can be affected by a number of factors, including product mix, production efficiency, and restructuring activities. Overall cost of revenues from continuing operations as a percentage of sales decreased in the three months ended August 31, 2014 from 76.1% to 74.0% compared to the same period last year. The SSC segment cost of revenues percentage for the three months ended August 31, 2014 decreased by 2.3 percentage points compared to the comparable period in 2013, primarily due a favorable product mix and improved efficiencies despite lower revenues in the quarter ended August 31, 2014. The EMS segment cost of revenues increased by 3.9 percentage points compared to the same period in 2013, primarily due lower revenues in the quarter ended August 31, 2014 compared to the same period last year. The SSIA segment realized an increase in cost of revenues of 5.9 percentage points primarily due to unfavorable product mix due to the completion of a contract in the quarter ended August 31, 2014 with a low margin profile. Combined restructuring costs recorded in the three months ended August 31, 2014 were approximately $0.4 million compared to approximately $0.0 million in the comparable period of 2013.

General and Administrative Expenses

General and administrative expenses decreased to approximately $6.0 million for the three months ended August 31, 2014 from $6.9 million for the three months ended August 31, 2013. The decrease is primarily a result of lower depreciation and amortization, lower stock based compensation due to forfeitures, lower professional fees and cost reductions following restructuring initiatives. As a percentage of sales, general and administrative expenses were 10.6% for the three months ended August 31, 2014, compared to 11.0% for the three months ended August 31, 2013.

The major components of general and administrative expenses are as follows:

 

		(dollar amounts in thousands) Three months ended August 31,
		2014				% of sales				2013				% of sales
Depreciation and Amortization		$	2,441				4.3	%		$	2,651				4.2	%
Accounting and Administration		$	1,873				3.3	%		$	2,061				3.3	%
Stock based compensation		$	(31	)			(0.1	)%		$	191				0.3	%
Professional Services		$	590				1.0	%		$	785				1.3	%

Selling Expenses

Selling expenses increased to approximately $3.7 million for the three months ended August 31, 2014 compared to approximately $3.5 million for the three months ended August 31, 2013. The increase is primarily a result of the timing of certain marketing-related expenses and additional sales salaries. As a percentage of sales, selling expenses were 6.6% for the three months ended August 31, 2014, compared to 5.6% for the three months ended August 31, 2013.

 

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The major components of selling expenses are as follows:

 

		(dollar amounts in thousands) Three months ended August 31,
		2014				% of sales				2013				% of sales
Payroll Expense – Sales		$	2,021				3.6	%		$	1,930				3.1	%
Commissions		$	1,046				1.8	%		$	1,042				1.7	%
Advertising		$	359				0.6	%		$	224				0.4	%

Research and Development Expenses

Research and development costs decreased to approximately $2.0 million for the three months ended August 31, 2014 compared to approximately $2.2 million for the three months ended August 31, 2013. As a percentage of sales, research and development expenses were 3.5% for the three months ended August 31, 2014, compared to 3.6% for the three months ended August 31, 2013.

Business acquisition and related charges

Business acquisition charges primarily represent costs of engaging outside legal, accounting, due diligence, business valuation consultants and accelerated stock option expenses related to business combinations or divestitures. For the three months ended August 31, 2014, business acquisition charges are approximately $0.2 million compared to approximately $(0.1) million for the comparable prior period, primarily related to actual costs being lower than previously estimated on the sale of the Sensors operations for the three months ended August 31, 2013.

Operating Income

We recorded operating income from continuing operations for the three months ended August 31, 2014 of approximately $2.7 million compared to operating income of approximately $2.3 million for the three months ended August 31, 2013. The increase in operating income of approximately $0.4 million is primarily attributed to a decrease in operating expenses and a change in product mix, partially offset by lower revenues in the quarter compared to the prior comparable period.

Other Expenses, Net

Total other expense for the three months ended August 31, 2014 are approximately $3.3 million, compared to other expense of $3.8 million for the three months ended August 31, 2013.

The decrease in other expense in the three month period ended August 31, 2014, compared to the comparable period in 2013, is largely attributable to lower amortization of note discounts and deferred financing costs as a result of the refinancing of our term loans and termination of our previous revolving loans in March 2014, partially offset by higher interest expense in the quarter ended August 31, 2014, compared to the comparable period in 2013, which had lower average borrowings.

Income Taxes

Income taxes from continuing operations amounted to a net expense of approximately $0.0 million for the three months ended August 31, 2014 compared to a net benefit of $3.1 million in the three months ended August 31, 2013. The expense during the three months ended August 31, 2014, is primarily due to the tax amortization of indefinite lived intangibles, and foreign and state taxes incurred during the period. The current provision is less than the statutory tax rate due to valuation allowances recorded for the deferred tax assets arising from current year losses. The prior year benefit related to the tax amortization of indefinite lived intangibles, and foreign and state taxes incurred during the period.

Income From Discontinued Operations

We had no activity in discontinued operations for the three months ended August 31, 2014, compared to net income from discontinued operations of approximately $5.3 million in the same period of fiscal 2013, which is primarily attributable to the operations of and the gain on the sale of Data Bus during the three months ended August 31, 2013.

 

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Net Income (Loss)

We recorded a net loss for the three months ended August 31, 2014 of approximately $0.6 million, compared to net income of approximately $7.0 million for the three months ended August 31, 2013. The increase in net loss in the three month period ended August 31, 2014 is largely due to the gain from the sale of Data Bus and the higher federal and state tax benefit in the three month period ended August 31, 2013, partially offset by lower amortization of deferred financing costs as a result of the refinancing of our term loans and termination of our previous revolving loans, and higher operating income in the three month period ended August 31, 2014, compared to the comparable period in 2013.

Results of Operations for the Nine Months Ended August 31, 2014 and 2013

The following discussion of results of operations is a comparison of our nine months ended August 31, 2014 and 2013.

Segment Operating Revenue and Adjusted EBITDA

 

		(dollar amounts in thousands) Nine months ended August 31,
		2014				2013				% Change
Revenues by segments:
SSC		$	120,809			$	128,112				(5.7	)%
EMS			31,510				44,362				(29.0	)%
SSIA			16,692				12,689				31.5	%
		$	169,011			$	185,163				(8.7	)%

We recorded an 8.7% decrease in overall revenues for the nine months ended August 31, 2014 over the same period in 2013. The decrease was due to lower revenues in our EMS and SSC segments, partially offset by higher revenues in our SSIA segment, compared to the nine months ended August 31, 2013. During the nine months ended August 31, 2014, the decrease in our SSC and EMS segment revenues was primarily due to timing of certain key defense programs. The SSIA revenues increased primarily due to new customer programs.

For a discussion of our definition of adjusted EBITDA, how management uses it to evaluate the performance of our reportable segments and the material limitations on its usefulness, refer to “Segment Operating Revenue and Adjusted EBITDA” on page 28.

 

		(dollar amounts in thousands) Nine months ended August 31,
		2014				2013				% Change
Segment Adjusted EBITDA:
SSC		$	16,082			$	17,294				(7.0	)%
EMS			(171	)			1,053				(116.2	)%
SSIA			2,624				2,478				5.9	%

The SSC segment adjusted EBITDA for the nine months ended August 31, 2014 was lower than the comparable period in 2013 primarily due to lower revenues, partially offset by improved efficiencies and product mix. During the nine months ended August 31, 2014, the decrease in our EMS segment adjusted EBITDA was primarily due to lower revenues, partially offset by cost reductions in the nine months ended August 31, 2014 compared to the same period last year. The higher adjusted EBITDA in the SSIA segment is a result of higher revenues, partially offset by a change in product mix in the nine months ended August 31, 2014, as we shipped products on a contract with lower margin.

 

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Operating Expenses

Cost of Revenues and Gross Margin

 

		Nine months ended August 31,
		2014				2013
Gross margin by segments:
SSC			26.9	%			26.5	%
EMS			4.6	%			7.1	%
SSIA			27.7	%			36.1	%
Overall			22.8	%			22.5	%

Our combined gross margin for the nine months ended August 31, 2014 increased by approximately 0.3 percentage points compared to the nine months ended August 31, 2013. Gross margin varies from period to period and can be affected by a number of factors, including product mix, production efficiency, and restructuring activities. Overall cost of revenues from continuing operations as a percentage of sales decreased in the nine months ended August 31, 2014 from 77.5% to 77.2% compared to the same period last year. The SSC segment cost of revenues percentage for the nine months ended August 31, 2014 was 73.1% compared to 73.5% in the comparable period in 2013 primarily due to a favorable product mix despite lower revenues. The EMS segment cost of revenues increased by 2.5 percentage points compared to the same period in 2013, primarily due to lower revenues, partially offset by cost reductions in the nine months ended August 31, 2014 compared to the same period last year. The SSIA segment realized an increase in cost of revenues of 8.4 percentage points primarily due to unfavorable product mix in the nine months ended August 31, 2014, as we completed a contract at August 31, 2014 with a lower margin profile. Combined restructuring costs recorded in the nine months ended August 31, 2014 were approximately $0.9 million compared to approximately $0.2 million in the comparable period of 2013.

General and Administrative Expenses

General and administrative expenses decreased to approximately $17.6 million for the nine months ended August 31, 2014 from $19.7 million for the nine months ended August 31, 2013. The decrease is primarily a result of lower stock based compensation due to forfeitures, lower depreciation and amortization, lower professional fees and cost reductions. As a percentage of sales, general and administrative expenses were 10.4% for the nine months ended August 31, 2014, compared to 10.6% for the nine months ended August 31, 2013.

The major components of general and administrative expenses are as follows:

 

		(dollar amounts in thousands) Nine months ended August 31,
		2014				% of sales				2013				% of sales
Depreciation and Amortization		$	7,388				4.4	%		$	7,949				4.3	%
Accounting and Administration		$	5,541				3.3	%		$	6,183				3.3	%
Stock based compensation		$	(99	)			(0.1	)%		$	791				0.4	%
Professional Services		$	1,464				0.9	%		$	1,939				1.0	%

Selling Expenses

Selling expenses decreased to approximately $11.0 million for the nine months ended August 31, 2014 compared to approximately $11.3 million for the nine months ended August 31, 2013. The decrease is primarily a result of lower commissions as a result of lower revenues. As a percentage of sales, selling expenses were 6.5% for the nine months ended August 31, 2014, compared to 6.1% for the nine months ended August 31, 2013.

The major components of selling expenses are as follows:

 

		(dollar amounts in thousands) Nine months ended August 31,
		2014				% of sales				2013				% of sales
Payroll Expense – Sales		$	6,231				3.7	%		$	5,991				3.2	%
Commissions		$	3,033				1.8	%		$	3,509				1.9	%
Advertising		$	899				0.5	%		$	810				0.4	%

 

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Research and Development Expenses

Research and development costs decreased to approximately $6.2 million for the nine months ended August 31, 2014 compared to approximately $6.9 million for the nine months ended August 31, 2013. As a percentage of sales, research and development expenses remained consistent at 3.7% for the nine months ended August 31, 2014 and 2013.

Business acquisition and related charges

Business acquisition charges primarily represent costs of engaging outside legal, accounting, due diligence, business valuation consultants and accelerated stock option expenses related to business combinations or divestitures. For the nine months ended August 31, 2014, business acquisition charges were approximately $0.4 million compared to approximately $1.0 million, primarily related to the sale of Sensors operations for the nine months ended August 31, 2013.

Operating Income

We recorded operating income from continuing operations for the nine months ended August 31, 2014 of approximately $2.4 million compared to operating income of approximately $2.1 million for the nine months ended August 31, 2013. The increase in operating income of approximately $0.2 million is primarily attributed to improved product mix and lower operating expenses, partially offset by lower revenues.

Other Expenses, Net

Total other expenses for the nine months ended August 31, 2014 is approximately $19.4 million, compared to other expense of $23.5 million for the nine months ended August 31, 2013. The decrease in other expense is largely attributable to lower interest expense in the nine months ended August 31, 2014, as a result of lower interest rates and lower average debt levels.

Income Taxes

Income taxes from continuing operations amounted to a net expense of approximately $0.7 million for the nine months ended August 31, 2014 compared to a net benefit of $3.3 million in the nine months ended August 31, 2013. The expense during the nine months ended August 31, 2014, is primarily due to the tax amortization of indefinite lived intangibles, and foreign and state taxes incurred during the period. The current provision is less than the statutory tax rate due to valuation allowances placed upon the deferred tax assets. The prior year benefit related to the tax amortization of indefinite lived intangibles, and foreign and state taxes incurred during the period.

Income From Discontinued Operations

We had no activity in discontinued operations for the nine months ended August 31, 2014, compared to net income from discontinued operations of approximately $18.1 million in the same period of fiscal 2013, which is primarily attributable to the operations of and the gains on the sales of our Sensors operations and Data Bus assets during the nine months ended August 31, 2013.

Net Income (Loss)

We recorded a net loss for the nine months ended August 31, 2014 of approximately $17.7 million, compared to net income of approximately $0.0 million for the nine months ended August 31, 2013. The increase in net loss is largely due to the gain on the sale of Sensors, which reduced the net loss in the nine months ended August 31, 2013, partially offset by lower interest expense from lower debt levels in the nine month period ended August 31, 2014, compared to the comparable period in 2013.

Liquidity and Capital Resources

Overview and Summary

Our principal sources of liquidity include cash flows from operations, funds from borrowings and existing cash on hand.

At August 31, 2014, we held cash and cash equivalents of approximately $7.7 million compared to $6.4 million at November 30, 2013. We believe that our available cash and cash equivalents and future cash flows from operations will be sufficient to satisfy our anticipated cash requirements for the next twelve months, including scheduled debt repayments, lease commitments, planned capital expenditures, and research and development expenses. There can be no assurance, however, that unplanned capital replacements or other future events, will not require us to seek additional debt or equity financing and, if so required, that it will be available on terms acceptable to us, if at all. Any issuance of additional equity could dilute our current stockholders’ ownership interests.

 

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On March 21, 2014, we entered into Amendment No. 2, which, among other things, amends the Term Loan Agreement to provide for the Incremental Term Loan Facility. The Incremental Term Loan Facility is subject to substantially the same terms and conditions, including the applicable interest rate and the maturity date of February 6, 2018, as the $165.0 million term loan facility provided upon the initial closing of the Term Loan Agreement. As of March 21, 2014, we had borrowed $126.7 million under the Term Loan Agreement. As of August 31, 2014, we had borrowed $123.4 million under the Term Loan Agreement.

The proceeds of the Incremental Term Loan Facility were used (i) to pay in full and terminate the Revolving Loan Agreement; (ii) to redeem all 26,000 shares of our Series A Mandatorily Redeemable Preferred Stock that were outstanding; (iii) to pay fees, costs and expenses associated with the Incremental Term Loan Facility and related transactions; and (iv) for general corporate purposes.

Term Loan Agreement

The term loans incurred pursuant to the Term Loan Agreement, as amended, including the term loans incurred pursuant to the Incremental Term Loan Facility (collectively, the “Term Loans”), bear interest, at our option, at the base rate plus 6.50% or an adjusted LIBOR rate (based on one, two or three-month interest periods) plus 7.50%. For purposes of the Term Loan Agreement, the “base rate” means the highest of Wells Fargo Bank, National Association’s prime rate, the federal funds rate plus a margin equal to 0.50% and the adjusted LIBOR rate for a 3-month interest period plus a margin equal to 1.00%.

Interest is due and payable in arrears monthly for Term Loans bearing interest at the base rate and at the end of an interest period (or at each three month interval in the case of Term Loans with interest periods greater than three months) in the case of Term Loans bearing interest at the adjusted LIBOR rate. Principal payments of the Term Loans are paid at the end of each of our fiscal quarters, with the balance of any outstanding Term Loans due and payable in full on February 6, 2018. The quarterly principal payments will amortize at 1.25% for the fiscal quarters through the end of our 2014 fiscal year, at 1.875% for the fiscal quarters through the end of our 2015 fiscal year and at 2.50% for each of the fiscal quarters thereafter.

Under certain circumstances, we are required to prepay the Term Loans upon the receipt of cash proceeds of certain asset sales, cash proceeds of certain extraordinary receipts and cash proceeds of certain debt or equity financings, and based on a calculation of annual excess cash flow. Mandatory prepayments resulting from assets sales or certain debt financings may require the payment of certain prepayment premiums.

The Term Loans are secured by a security interest in substantially all of the assets owned by the Company and the subsidiary guarantors.

The Term Loan Agreement contains customary affirmative and negative covenants, including covenants that limit or restrict the Company and its subsidiaries’ ability to, among other things, incur indebtedness, grant liens, dispose of assets and pay dividends or make distributions to stockholders, in each case subject to customary exceptions for a term loan of this size and type.

Pursuant to the Term Loan Agreement, we are required to maintain compliance with an interest coverage ratio and a leverage ratio and to limit our annual capital expenditures to $4.0 million per fiscal year (subject to carry-over rights). The interest coverage ratio is defined as the ratio of Consolidated EBITDA to cash Interest Expense (as each term as defined in the Term Loan Agreement), as at the end of each fiscal quarter. For each of the fiscal quarters during the fiscal year ending November 30, 2014, the interest coverage ratio must be not less than the ratio of 2.10:1.00. The leverage ratio is defined as the ratio of Funded Debt to Consolidated EBITDA (as each term as defined in the Term Loan Agreement), as at the end of each fiscal quarter. For each of the fiscal quarters during the fiscal year ending November 30, 2014, the leverage ratio must be not greater than the ratio set forth opposite such period below:

 

Applicable Ratio		Test Period Ending
5.75:1.00		February 28, 2014
5.50:1.00		May 31, 2014
5.50:1.00		August 31, 2014
5.50:1.00		November 30, 2014

 

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As at August 31, 2014, the Company was in compliance with its financial covenants under the Term Loan Agreement.

The Term Loan Agreement includes customary events of default including, among other things, non-payment defaults, inaccuracy of representations and warranties, covenant defaults, cross default to material indebtedness, bankruptcy and insolvency defaults, non-compliance with ERISA laws and regulations, defaults under the security documents or guaranties, material judgment defaults, and a change of control default, in each case subject to certain exceptions for a term loan of this type. The occurrence of an event of default could result in an increased interest rate equal to 2.0% above the applicable interest rate for loans, the acceleration of our obligations pursuant to the Term Loan Agreement and an obligation of the subsidiary guarantors to repay the full amount of our borrowings under the Term Loan Agreement. If we were unable to obtain a waiver for a breach of covenant and the lenders accelerated the payment of any outstanding amounts, such acceleration may cause our cash position to deteriorate or, if cash on hand were insufficient to satisfy the payment due, may require us to obtain alternate financing to satisfy the accelerated payment. If our cash is utilized to repay any outstanding debt, we could experience an immediate and significant reduction in working capital available to operate our business.

Nine Months Ended August 31, 2014 Compared to August 31, 2013

Cash generated by operating activities of approximately $2.0 million for the nine months ended August 31, 2014 (“Q3 YTD FY2014”) was higher than cash used by continuing operations of approximately $6.8 million for the nine months ended August 31, 2013 (“Q3 YTD FY2013”). The increase in cash generated by operating activities resulted primarily from a decrease in the net cash used by changes in operating assets and liabilities during Q3 YTD FY2014. The decreased use in cash from changes in operating assets and liabilities in Q3 YTD FY2014 compared to Q3 YTD FY2013 was primarily related to changes in inventory and accounts payable.

Cash generated by investing activities for the nine months ended August 31, 2014 was approximately $16.1 million, which consisted primarily of the $15.1 million proceeds from the sale of the State College facility, $1.5 million related to the release of restricted cash from the sale of Sensors and a $1.4 million tax refund related to the SenDEC acquisition, partially offset by the acquisition of fixed and intangible assets of $1.8 million. Cash generated by investing activities for the nine months ended August 31, 2013 consisted of approximately $80.5 million from the sale of Sensors, Data Bus and the release of $0.7 million held in restricted cash for the Commercial Microwave Technology, Inc. (“CMT”) final payment, partially offset by $1.5 million related to an escrow for the sale of Sensors, $2.6 million related to the acquisition of fixed and intangible assets and $0.6 million related to the final payment of the CMT purchase price.

Cash used by financing activities for the nine months ended August 31, 2014 totaled approximately $16.8 million, which resulted from the repayment of long-term debt, mainly related to term loans under the Term Loan Agreement, the repayment and termination of the Revolving Loan Agreement and the $27.6 million redemption of preferred shares, partially offset by net proceeds associated with the Revolving Loan Agreement. During the nine months ended August 31, 2013 cash used by financing of approximately $80.7 million consisted mainly of repayment of term loans using a portion of the proceeds from the sales of Sensors operations and Data Bus assets and the repayment of certain capital lease obligations.

Contractual Obligations

In December 2013, we decreased our Term Loans by $14.2 million using a portion of the proceeds from the Sale/Leaseback and capital lease obligations increased by approximately $5.2 million. Term Loans increased by $55.0 million as a result of Amendment No. 2 in March 2014. These proceeds were principally used to repay in full our Revolving Loan Agreement and to redeem and cancel the Series A Redeemable Preferred Shares.

Critical Accounting Policies and Estimates

We describe our significant accounting policies in Note 2 and the effects of recently adopted accounting pronouncements in Note 3 to the unaudited consolidated financial statements in Item 1 of this Report. There were no significant changes in our accounting policies or critical accounting estimates that are discussed in our Annual Report on Form 10-K for the year ended November 30, 2013.

Off-Balance Sheet Arrangements

During the year ended November 30, 2013 and the three months ended August 31, 2014, the Company did not have any off-balance sheet arrangements.

 

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FORWARD-LOOKING STATEMENTS

This document and the documents incorporated in this document by reference contain forward-looking statements that are subject to risks and uncertainties. All statements other than statements of historical fact contained in this document and the materials accompanying this document are forward-looking statements.

The forward-looking statements are based on the beliefs of management, as well as assumptions made by and information currently available to management. Frequently, but not always, forward-looking statements are identified by the use of the future tense and by words such as “believes,” “expects,” “anticipates,” “intends,” “will,” “may,” “could,” “would,” “projects,” “continues,” “estimates” or similar expressions. Forward-looking statements are not guarantees of future performance and actual results could differ materially from those indicated by the forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause the Company or its industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking statements.

The forward-looking statements contained or incorporated by reference in this document are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (“Securities Act”) and Section 21E of the Exchange Act and are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. These statements include declarations regarding our plans, intentions, beliefs or current expectations.

Management wishes to caution investors that any forward-looking statements made by or on behalf of the Company are subject to uncertainties and other factors that could cause actual results to differ materially from such statements. Among the important factors that could cause actual results to differ materially from those indicated by forward-looking statements are the risks and uncertainties described under “Risk Factors” in our Annual Report on Form 10-K for the year ended November 30, 2013 and in our other filings with the SEC. These uncertainties and other risk factors include, but are not limited to: general economic and business conditions, including without limitation, reductions in government defense spending; governmental laws and regulations surrounding various matters such as environmental remediation, contract pricing and international trading restrictions; our ability to integrate and consolidate our operations; our ability to expand our operations in both new and existing markets; the ability of our review of strategic alternatives to maximize stockholder value; the effect of growth on our infrastructure; our ability to maintain compliance with our financial covenants; and continued access to capital markets.

Management wishes to caution investors that other factors might, in the future, prove to be important in affecting the Company’s results of operations. New factors emerge from time to time and it is not possible for management to predict all such factors, nor can it assess the impact of each such factor on the business or the extent to which any factor, or a combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

Forward-looking statements are expressly qualified in their entirety by this cautionary statement. The forward-looking statements included in this document are made as of the date of this document and management does not undertake any obligation to update forward-looking statements to reflect new information, subsequent events or otherwise.

 

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ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency

Certain of our European sales and related selling expenses are denominated in Euros, British Pounds Sterling, and other local currencies. In addition, certain of our operating expenses are denominated in Canadian dollars, Mexican Pesos and Chinese Yuan. As a result, fluctuations in currency exchange rates may affect our operating results and cash flows. For each of the periods presented herein, realized currency exchange rate gains and losses were not material.

Interest Rate Exposure

We have market risk exposure relating to possible fluctuations in interest rates. We may utilize interest rate swap agreements in the future to minimize the risks and costs associated with variable rate debt, however, we have not done so to date. We do not enter into derivative financial instruments for trading or speculative purposes. As of August 31, 2014, the Company has borrowed $123.4 under its Term Loan Agreement. The loan amounts under the Term Loan Agreement bear interest at adjusted LIBOR plus 7.5%, all of which is subject to variable interest rates. The adjusted LIBOR, as defined in the Term Loan Agreement, has a floor of 1.50%. Based on LIBOR at August 31, 2014, an increase of 1.0% in interest rates would result in a 0.1% increase on the existing term loans, due to the 1.50% floor, or a $0.1 million increase in our overall annual interest expense and related cash payments. Absent the 1.50% floor, a 1.0% change in interest rates would result in a $1.3 million change in our annual interest expense and related cash payments on Company’s borrowings, assuming the entire $130.1 million was outstanding. Such potential increases or decreases are based on certain simplified assumptions, including minimum quarterly principal repayments made on variable-rate debt for all maturities and an immediate, across-the-board increase or decrease in the level of interest rates with no other subsequent changes for the remainder of the periods. Any debt we incur in the future may also bear interest at floating rates.

 

ITEM 4.

CONTROLS AND PROCEDURES

Controls and Procedures

 

(a)	Evaluation of Disclosure Controls and Procedures.

We maintain “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended. We have carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of August 31, 2014. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of August 31, 2014.

 

(b)	Changes in Internal Control over Financial Reporting

During the quarter ended August 31, 2014, there have been no changes in our internal control over financial reporting that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

 

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PART II – OTHER INFORMATION

 

ITEM 1.

LEGAL PROCEEDINGS

Information with respect to legal proceedings can be found in Note 15 “Commitments and Contingencies” to the Consolidated Financial Statements contained in Part I, Item 1 of this report.

 

ITEM 1A.

RISK FACTORS

There are no material changes from the risk factors set forth under Part I, Item 1A—“Risk Factors” in our Annual Report on Form 10-K for the year ended November 30, 2013.

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a) None.

(b) Not applicable.

(c) None.

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

None.

 

ITEM 4.

MINE SAFETY DISCLOSURES

Not applicable.

 

ITEM 5.

OTHER INFORMATION

None.

 

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ITEM 6.

EXHIBITS

 

Exhibit Number		Exhibit Title
31.1		Rule 13a-14(a)/15d-14(a) Certification by Chief Executive Officer (filed herewith).
31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer (filed herewith).
32.1		Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002 (filed herewith).
32.2		Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002 (filed herewith).
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema Document
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

				API TECHNOLOGIES CORP.
Date: October 3, 2014				By:		/s/ CLAUDIO MANNARINO
						Claudio Mannarino
						Senior Vice President and Chief Financial Officer (Duly Authorized Officer)

 

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